Personal Finance: Individual investors are gaining confidence

Personal Finance: Individual investors are gaining confidence

November 13th, 2013 Chris Hopkins in Business Diary

Chris Hopkins

Photo by Patrick Smith/Times Free Press.

The bull market that began in 2009 has gotten less respect than Rodney Dangerfield, particularly among individual investors who remember how awful the picture looked in 2008. Runaway federal debt, endless manufactured political crises, household deleveraging and stagnant wage growth have contributed to the skepticism, making it harder to commit to a market that has blown up twice in recent memory.

It finally looks like the tide is turning and investors are coming off the sidelines. As recently as October, the Investment Company Institute reported results of its annual survey indicating that mutual fund investors were even more reluctant to take risk than they were in 2008. Since that survey was conducted, a distinct change in attitude is evident, and market optimism is gaining momentum. Under normal circumstances, such a shift would be cause for concern, as extremes in sentiment often foreshadow unpleasant reversals in markets.

This time, however, it may be just what the doctor ordered. One justification for the enormous liquidity injections provided by the Federal Reserve has been an attempt to offset the distinctly negative sentiment that has kept cash out of the game. The Fed's action has clearly muscled stock prices higher, but has so far not engendered any significant fundamental revitalization in the real economy. Only the willingness of businesses and households to engage in risk-taking feeds the requisite "animal spirits" necessary to support robust growth.

Albeit reluctantly, investors are grudgingly becoming more optimistic of late, thanks no doubt to the market's relentless march higher against numerous headwinds. The American Association of Individual Investors conducts a respected weekly survey of its members, and the latest results indicate that 46 percent are now bullish. This compares to a long-term average reading of 39 percent. Respondents claiming to be bearish made up just 22 percent, well below the average of 30 percent.

And it is not just survey results that are telling the tale; investors are voting with their wallets. The Investment Company Institute tracks fund flows into and out of mutual funds, and reports a notably more positive trend this year. U.S. equity funds have enjoyed an estimated $17 billion in inflows so far in 2013, following five consecutive years of outflows totaling nearly $550 billion. It doesn't get us back anywhere near pre-recession levels, but it's a start.

Contrarians always look to extremes in sentiment as one clue to a market reversal, so some analysts are understandably nervous about the shift. But by most conventional measures, the stock market is not wildly overpriced; the S&P 500 is trading at just about 15 times next year's earnings, slightly above average but not disturbingly so. And earnings reports have roundly exceeded expectations once again this quarter, providing more runway for stock prices to move higher. As we have discussed recently, some more ephemeral tech issues are clearly ahead of their fundamental values, but the broader market appears to have more room to run.

More importantly, it looks like individual investors are finally gaining more confidence, which is an indispensable precondition for a return to normality.

Christopher A. Hopkins, CFA, is a vice president for Barnett & Co. Investment Advisors. If you have personal finance questions, you may send them to business@timesfreepress.com.