In or out? The case for – and against – the stock market

The American stock markets climbed all summer, and were nearing record highs before the Dow Jones Industrial Average fell 243.36 points last week, down almost 4% from a five-year peak. Yet even before the drop, many investors didn’t trust the rally.

“This is the most disliked rally I can ever remember,” Charles Rotblut, vice-president of the Chicago-based American Association of Individual Investors, said last week, referring to the recent stock run up, which ended abruptly after a string of dismal third quarter earnings reports. Washington gridlock – including speculation about the upcoming Presidential election, stubborn unemployment and the stalemate in Europe were making investors uncertain, Rotblut notes. Weekly surveys of the sentiments of the Association’s 150,000 members (with the option to pick “bearish”, “bullish” or “neutral”) have revealed bullish outlooks to be below average for 28 of the past 29 weeks. Bond allocations among surveyed members have been above average for more than three years.

Many investors are frustrated with low yields, they don’t have confidence in the market and they are worried about “another shoe dropping”, Rotblut says. “And nobody counts how many people have just checked out of the market,” he adds. “They tend to just very quietly move away.”

Wharton professors disagree about which way stock markets are headed and whether investors should be in or out. Some have pulled their own investments out of equities and don’t plan to return. Others say bearish investors are hurting themselves by withdrawing at the worst possible time and missing out on the market’s upside.

Chris Goolgasian doesn’t need surveys to tell him how retail investors feel about the stock market these days. As head of the US portfolio management and investment solutions group for Boston-based State Street Corp, he meets regularly with brokers and advisors who manage individual client portfolios. In as many as 80 meetings since April, they have all said the same thing: how do I get my clients out of cash and bonds? “This is repeated at every meeting,” Goolgasian notes. “These advisors are meeting clients who are extremely bearish.”

Investors have moved about $2 trillion into cash and fixed income since the financial crisis, Goolgasian says. And despite a number of indicators that suggest the market today is “a fairly low risk environment,” many retail investors “don’t want to hear it. Money flow weekly is still out of equity funds and into bonds and cash.”

Investors who have swapped equities for bonds have “exchanged nominal safety for a real loss,” Goolgasian points out. “They are getting ‘safety’ in their accounts in that they are not seeing volatility…. But they are going to suffer real losses because the bonds and cash they bought are earning less than the inflation rate.”