Stocks on a roll, but small investors miss the party
The stock market is on a roll this year. The pros are bullish, yet John and Jane Public are still scared of stocks.
The market, as measured by the S&P 500 Index, is up 12 percent so far this year, its best first-quarter rally since 1998. But small investors are missing the party.
They have been yanking money out of domestic stock mutual funds nearly constantly for five years, although their rate of retreat has been slowing recently, according to figures from the Investment Company Institute.
The little guys have been piling into bonds instead, despite rock-bottom interest rates that are often below inflation.
Market pros — the snooty ones — are saying it’s just what they expect: the amateurs sell when they should buy and vice versa.
That behavior is actually a bullish sign, the pros say. Small investors will eventually come around, and when they do, they’ll drive stocks higher.
The pros generally have been piling into stocks, as evidenced by the sharp rise in the S&P, an index of big-company stocks. It is up 31 percent from October, the bottom of last year’s correction.
Prices could go 10 percent higher, says Joe Williams, director of investment strategy at Commerce Trust Company, part of Commerce Bank. “This market still offers good value.”
Stocks follow prospects for company earnings more than anything else. The consensus among analysts has come down a bit, but they still expect an 8 percent to 9 percent rise in profits this year. That’s lower than the last two years, but still a healthy jump.
Today’s profits make stocks look cheap, the gurus say, although not nearly as cheap as they were in October. Stocks are still selling at 13 times this year’s expected earnings, compared to a historical average of 15.
During most of that history, stocks got tougher competition from bonds. But with rates on the 10-year T-bonds at 2.2 percent, bonds are looking ugly as investments, analysts say.
“The value is much greater in quality stocks than in bonds,” says Al Goldman, who spent 50 years watching markets at A.G. Edwards, retiring as chief market strategist.
Market pros are salivating over the $2 trillion in cash sitting in corporate treasuries. Some of that will be paid out in higher dividends, notes Craig Fehr, investment strategist at Edward Jones in Des Peres.
SPOILERS
What could poop the stock party? War, for one. The oil market is worried that Israel may bomb Iran soon, and that Iran may try to plug the world’s biggest oil bottleneck in response. That partly explains today’s high gasoline prices.
Bad news on the U.S. economy also could knock the optimism out of corporate profit projections. Most of the recent news has been good, but progress is still plodding and uncertain.
“We think that modest growth is sustainable,” says Fehr, noting three months of 200,000-plus job growth. “As more people have jobs, that’s more money spent in the economy.”
Farther out, the market may start to worry that Congress will let the tax breaks on dividends and capital gains expire as scheduled with the new year. The tax battle after election day could also bring yet another threat of government shutdown or a debt ceiling crisis of the sort that rattled confidence last year.
That’s why market optimists expect some market bumps. Over the past century, stocks have averaged three 5 percent pullbacks and one 10-percent correction every year. This year may be no different, says Fehr.
Others think not. “We do need a rest, but bull markets surprise on the upside. We may never have a drop of 10 or 15 percent so money on the sidelines can get in,” Goldman said.
As the market rose this year, its darlings were changing. When the economy looked shakier last year, investors drove up shares in utilities and some health care and consumer staples. Investors fell in love with dividend stocks.
This year, with confidence improving, technology stocks and some industrials are in vogue.
Joe Terril, who manages more than $400 million at Terril & Company in Sunset Hills, is partial to big-bank stocks. “Even though there’s been a nice rally, they are still very reasonably priced,” said Terril. He likes Citi, and Bank of America — despite their near-death experience in 2008 — along with Wells Fargo and J.P. Morgan Chase.
Technology is another popular pick. Terril likes networking equipment maker Cisco, scientific measuring products business Agilent and laser and optical products company Coherent.
The market is in love with Apple, and it’s sent the stock price up 50 percent so far this year. Investors are betting the company can continue the march of innovation that produced the iPod, iPhone and iPad over the past decade.
Terril is worried that it might not. If it doesn’t, those products will go stale with age and increased competition, with fewer buyers willing to fork out for the newest version.
He notes that Apple’s stock is now worth more than some entire industries.
“How can Apple be worth more than every publicly-traded utility in the country?” Terril asks.
By contrast, Williams is an Apple fan. The company is only selling at 15 times earnings, he notes. He also likes software company Microsoft and Web search engine Google.
“You want to be with the leaders in technology. You don’t want to play the laggards and wait for them to catch up,” he argues.