Institutional investors are less likely to divest from equities, given spending goals that can’t be met with bonds earning 1.5%, Goolgasian notes. Individual investors, on the other hand, are suffering from a number of ‘isms’: “Pessimism about the job market, skepticism about the equity rally and cynicism about our political leaders and their ability to pull us out of this.”
Many investors pulled their money out of the market in 2008 and haven’t come back, scared of volatility and still reeling from the drama of the Flash Crash in 2010. That’s been a mistake, according to Wharton finance professor Jeremy Siegel. Even factoring in Tuesday’s drop, the market’s value has doubled since March 2009. Volatility has eased. For equity investors, Siegel sees sunny days ahead.
“The public unfortunately lags [behind] what’s going on in the market,” says Siegel, noting that rank-and-file investors tend to be bullish at the top of the market and bearish when the market is about to recover. “It is not unusual for the public to miss the first half to two-thirds of a bull market. Then they get in at the end, and they ride it down.”
To sophisticated market watchers, the fact that most retail investors are staying out of the market right now is actually a positive indicator, since history shows that public flows in and out of the market are usually badly timed, Siegel says. “I still think this bull market definitely has room to run,” he notes. “I can easily see stocks up another 20% to 30% from these levels in a year or two.”
Wharton finance professor Franklin Allen holds the opposite view — as well as opposite investments. “I don’t have much in the stock market at all anymore,” notes Allen, who describes himself as risk-averse. “It’s in Treasuries and real estate.”
Allen says he doesn’t know why the stock market is as high as it has been lately, and wonders if it’s a bubble. The recent rally may have more to do with quantitative easing by the Federal Reserve (QE3) than a positive economic outlook, he notes. Despite low returns on bonds and Treasuries, Allen says he wouldn’t go back into the market unless equity prices dropped by about 30%. “If you think the market is going to drop, then zero [return] is better than minus-20,” Allen points out. “That’s the perspective that people who are pulling out are using.”
Wharton finance professor Richard J. Herring says the market outlook remains uncertain. “It is hard to imagine earnings continuing to grow since they are already at an historical high relative to GDP, and the economic outlook is tepid at best,” he notes. “Many experts believe this is a market pumped up by QE3 and little else.”
Market volatility over the past few years may be keeping investors away, Herring suggests. “Although we are now back to about where we were in 2006, it has been a horrifying ride, and some investors bailed out at precisely the wrong time because they were terrified it could go still lower.”
A crisis of confidence?
Confidence in the markets has been damaged in a variety of other ways, with a number of incidents causing individual investors to wonder how well they are being protected by institutions such as the Securities and Exchange Commission, Herring adds. “The Madoff scandal, MF Global, the flash crash, the software error at Knight Capital, the NYSE settlement with the SEC over information sold preferentially to a program trader, the bizarre spectacle of the Facebook IPO and scandals at several major banks all have undermined the confidence of individual investors that they can be treated fairly,” he says. “It seems like a game rigged against [them].”
This is costly to society, because it means that less capital will be available for risk-taking and the liquidity of markets will diminish, Herring notes. “Although many overlook the point, we should realize that confidence in the markets is an enormously valuable public good. If investors trust that they will be treated fairly, they will be much more likely to place their savings in marketable instruments, and both the quality and quantity of capital formation will be improved.”
About 46% of American households held investments in stocks or stock funds at the end of 2011, down from 53% in 2001, according to the Investment Company Institute, a Washington, D.C.-based association of U.S. investment companies. “We have seen outflows from domestic mutual funds since 2007,” says Investment Company Institute senior economist Shelly Antoniewicz. Yet she says it would be wrong to suggest that investors are simply running away from stocks. “We don’t think that investors are fleeing” domestic equity markets, she adds. “We think of it as diversification.”
For example, from the beginning of 2007 to August 2012, a total of $196 billion flowed out of domestic mutual funds and exchange traded funds. During that same period, $361 billion went into international equity mutual funds and ETFs, which “more than offsets all the flows out of domestic equity,” Antoniewicz says out.
