With investors returning to stocks, some preach caution

November 15, 2013 

You couldn’t pry individuals away from the safety of bonds, cash and CDs as the stock market climbed 26 percent within a month of hitting a scary low in March 2009 amid the financial crisis. You couldn’t tempt most people to give stocks a try as the stock market doubled in the next couple of years.

And even now, with the Standard & Poor’s 500 index up about 162 percent since March 2009, there are people who insist “never again” to anyone suggesting investors put some of their savings in the stock market.

But as the stock market has hit one record after another this year, individuals have begun to let go of fear. They have poured $76 billion into stock mutual funds — the most enthusiastic flow of money since 2004. The Standard & Poor’s 500 has climbed an unusual 24 percent this year; more than twice the 10 percent annual historical average for the market.

You might think analysts would be happy to see regular Americans getting into the stock market. After all, enthusiast stock buying lifts stock prices higher. But instead, professionals are starting to worry that individuals might overdo it, and that it could portend trouble for the stock market.

One school of thought among professionals is that individual fervor for the stock market is a warning sign. Novice investors tend to get excited about stocks at the wrong times. They cower when stocks are deeply depressed even though bargain prices entice savvy investors and end up in grandiose gains. And individuals mistake a soaring stock market as a safe market. They buy with abandon just as stocks are poised to fall, and then are unnerved by downturns of 5 percent to 10 percent even though they happen on average every three years.

Those downturns — known as “corrections” — happen because investors become too enamored with the stock market and buy stocks at prices that are too high, given profits companies are generating. Once stocks have fallen to more reasonable levels, investors start buying them again and prices climb. More extreme downturns of 20 percent or more happen on average every five years.

Currently, most analysts are not predicting an extreme downturn. But after more than four years of rising stock prices, analysts are debating whether stocks can continue to climb into the end of the year, and keep it up next year, without a correction. There is disagreement about whether enthusiasm has pushed stocks to lofty prices that must come down.

The Leuthold Group, for example, is among those arguing that stocks look overvalued. But even as Leuthold analysts note today’s values are high compared with historic numbers, they point out that stocks can continue to climb for months or years at inflated prices — so trying to time a move to the exits is folly. Likewise, S&P Capital IQ strategist Sam Stovall pointed out a recent obsession with “cautioning investors about an impending stock correction.” But he emphasized that no one can predict when corrections will arrive; even if stocks are pricey. “While a correction might be due, it will also likely be delayed,” Stovall said.

John Rekenthaler, Morningstar vice president of research, argued this week in a Morningstar. com article that individual investors are not showing the level of exuberance for stocks that is a precursor to a dramatic market decline.

He contrasts the $76 billion they have invested in stock mutual funds this year with the $451 billion they removed in the past seven years.

“One year’s worth of positive inflows from fund investors has not been a danger sign,” he said. Before the stock market crashed 57 percent from late 2007 to early 2009, individuals had been pouring money into stock mutual funds for five consecutive years. Before the 49 percent crash in 2000-2002, he noted, investors had fed billions into stock mutual funds over 11 straight years.

Still, while manias for stocks usually build over long periods of time, investors are skeptical of the recent run-up in stock prices. And that could unleash a decline if either the economy or corporate profits fall short of expectations.

In a survey of global fund managers done by Bank of America Merrill Lynch this month, 68 percent said stocks are expensive. That’s the highest level since January 2002.

Merrill Lynch strategist Michael Hartnett suggested in a report that investors “temper their enthusiasm” for year-end rallies, especially for Internet stocks and small-company stocks with dramatic increases.

That doesn’t mean to dump all your stocks, assuming you have a thoughtful mixture of stocks, bonds and cash. But it does mean not to buy a lot of stocks now with the belief a soaring market assures you of safety.

Gail MarksJarvis is a personal finance columnist for the Chicago Tribune and author of “Saving for Retirement Without Living Like a Pauper or Winning the Lottery.” Readers may send her email at gmarksjarvis@tribune.com.

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