The six-figure inheritance Peter Duchenes received three years ago is about to hit the stock market.
When he first got the money, the 51-year-old actor and director decided to park it in a bank savings account. The interest on it was paltry, but he had no appetite for stocks – put off by the losses he sustained in an account he had with an investment adviser and worried about the upheaval in financial markets.
But this week, the Ottawa resident opened a new discount brokerage account. Once the paperwork is done, he will join the many investors who are finally getting over the trauma of the great crash of 2008-09 and diving back into equities. After three years of educating himself about the markets, he’s planning to invest the money in exchange-traded funds, which are index-tracking investments that trade like a stock.
Memories, even awful ones, do fade. That’s proving true for the legions of investors who were psychologically scarred by the meltdown that happened more than four years ago and carved billions of dollars off Canadians’ collective net worth. “Part of it is the distance from the big collapse,” Mr. Duchenes said of his plan to go back into the market. And suddenly, there are a lot more people thinking the same thing.
They are investors who are having pangs of regret about missing the four-year bull market that followed the crash, and who are tired of watching their money grow at 1 or 2 per cent in a savings account, or government bonds that pay little more than that. If they’re worried about anything at the moment, it’s that they’ll squander an opportunity to profit from an upturn in the global economy. “Everybody’s still scared,” said Peter Puccetti, founder and chief investment officer of Goodwood Inc., a Toronto fund management company, but “it’s another form of fear – fear of missing the rally. People see the market rally and want some of that.”
The Dow Jones industrial average closed above 14,000 on Friday for the first time since October, 2007, and is closing in on its all-time high 14,164. The Standard & Poor’s 500, the best single measure of the health of the U.S. stock market, went up 5.2 per cent in January, its best performance for that month since 1987; it, too, is near a record high. The S&P/TSX composite, Canada’s benchmark index, has now recovered all the ground it lost since Lehman Brothers Holdings Inc. collapsed on the morning of Sept. 15, 2008.
Individual investors are responding. Tellingly, in the four weeks ended Wednesday, U.S. investors poured $20.7-billion (U.S.) into equity mutual funds – the highest four-week total since April, 2000, according to Thomson Reuters/Lipper.
A survey of sentiment by the American Association of Individual Investors this month hit its most bullish level in more than a year. Investment advisers and other financial professionals also report a change in mood among Canadian investors. “The rally is real. Money is in motion. Retail investors are coming back in,” said Noel Archard, who runs the Canadian unit of BlackRock Inc., one of the world’s largest asset managers.
All of this is a reversal of what has been a lengthy abandonment of equities by the retail investor. Scarred by scandals, beaten down by two historic bear markets since the turn of the century, investors have been pulling money from stocks and shifting to bonds and cash for years, even in the United States, which has one of the strongest equity cultures in the world.
In a Gallup poll last year, 53 per cent of Americans said they owned stocks, the lowest percentage since the polling company began asking the question in 1998. The Investment Company Institute, a lobby group for the U.S. mutual fund industry, says that 2007 was the last most recent year U.S. investors put more money in to stock funds than they took out.
Four weeks may not make a trend; investors could change their minds later this year and turn on stocks once again. But a perceived lessening of risk, a lack of investment alternatives, and a view that the global economy, particularly the U.S., is getting better may combine to herald the return of the individual to the markets.
“It’s a sentiment issue, and it just seems like sentiment is starting to turn,” said Greg Holohan, senior wealth adviser at ScotiaMcLeod in Markham, Ont. “People are in a position now where they feel certain stocks are worth the risk.”
The big question is: Are they right?
THE ‘RECENCY‘ EFFECT
It’s easier, first, to examine what is happening to cause a brighter mood. And that is as much a story about the human brain as it is about the euro zone crisis or the U.S. debt ceiling.
Human beings tend to make decisions based on what they remember most vividly. In psychology, this is called the “recency effect” – we tend to remember newer information better, and it influences behaviour more strongly than older information, which gets hazier over time.
Meir Statman, author of the book What Investors Really Want and a behavioural finance professor at Santa Clara University in California, describes investors’ post-crisis approach to stocks as similar to a bad road trip.
He paints this scenario: You’re driving down the highway when the truck in front of you suddenly slams its brakes. Your heart jumps into your throat, but you stop just in time. Naturally, your nerves are going to be on edge until you get out of the car.
But the market crash in 2008 and 2009 “is a case where we plowed into the truck,” Prof. Statman said.
Any driver who has ever been in a bad car accident knows it takes a while to get back on the road. But eventually, the mental scars heal. It’s the same for investors who lose money. “They see the future as being more positive [now], and they see stocks as being more positive,” Prof. Statman said.
The market has lurched from one apparent crisis to another over the past several years. Once the financial crisis had eased in 2009, it was replaced by worries of a collapse in the euro zone because of the unsustainable debts of member countries such as Greece and Ireland. Then, in 2011, that was coupled with concerns about U.S. political leadership, which brought the world’s largest economy to the edge of a debt default in an argument over taxes and spending.
Now, with the Jan. 1 resolution of the U.S. “fiscal cliff” and the euro zone crisis receding, many of the negative headlines have been removed – or investors have simply tuned them out.
After all the dire warnings, the sky hasn’t fallen and people have stopped reacting reflexively, said Michael Obuchowski, a portfolio manager with North Shore Asset Management in Cold Spring Harbor, N.Y., who holds a doctorate in clinical psychology.
He calls it “systematic desensitization.” In other words, “when you repeat it [the fears of economic calamities] 200 times over two years, people really stop paying attention to it. They become desensitized to that type of information.”
Or, perhaps, we have reached a point where there truly are fewer risks investors need to worry about.
“There are no ‘known unknowns’ right now,” says Pierre Lapointe, the head of global strategy and research at Pavilion Global Markets Ltd., using a phrase made famous by former U.S. defence secretary Donald Rumsfeld. “It’s the first time since the beginning of 2007 that we see much less uncertainty.”
That allows market watchers to turn their attention to economic news, which has generally been positive for several months, as well as corporate profits, which have been at record levels for two years.
The tangible numbers of people buying cars and homes and finding jobs have been improving since the second half of last year. Now that the risk-driven headlines are disappearing, investors like what they see.
The experience of Canadian investment advisers suggests investors have become more open-minded about stocks. Advisers report that clients are moving money out of savings accounts and into mutual funds that either mix stocks and bonds together or hold only stocks. Those who already have balanced portfolios are moving into more aggressive blends of stocks and bonds.
A big factor in this recent shift in attitude toward stocks, says a veteran adviser in Waterloo, Ont., is the arrival of 2012 account statements. The S&P/TSX composite index was up 7.2 per cent last year, including dividends, and the average Canadian equity fund return was 7 per cent. “A lot of people were surprised how positive things were last year, based on what they’d heard from their neighbours and the press,” said the adviser, who declined to be named because her company does not allow her to be quoted by the media.
And that 7 per cent, while much lower than what a lot of global equity markets returned last year, compares very favourably to federal and provincial government bonds, whose yields are so small that, after taxes and inflation, the investor gains little – or worse.
“People are finally getting through their heads that part of my risk is negative real yield” and declining purchasing power, says BlackRock Canada’s Mr. Archard. “If I’m going to really have a long-term portfolio ... I’ve got to be in [stocks].”
SOME BULLS TURNING CAUTIOUS
Let’s say the positive feelings continue and investors spend the first part of the year making the switch back to stocks. Are they right on time, or too late?
Mr. Archard thinks the rally will last as investors start to understand the improving economic fundamentals in some regions, including the U.S.
“Last year was a really nice year across multiple asset classes, and if you thought about the day-to-day conversation, it wasn’t about, ‘Hey we have nice equity returns, nice fixed-income returns.’ It was, ‘Is Greece going to blow up? Is Italy going to blow up? Is the U.S. going to blow up?’
“And in the midst of that, [many] economies are slowly creeping back to solid ground. That’s what the focus is on and why I’m still feeling like this is a long-term good story.”
Still, many professional strategists who have been bullish on the markets – and have seen the markets gain almost as much in January as they had projected all year – are now growing cautious.
George Vasic, who until this week was the Canadian equity strategist for UBS, said that with corporate profit margins at a peak and economic growth likely to be slow, the markets should trade at a discount to their normal levels. The long-term average for North American stocks is to trade between 14 and 15 times earnings estimates for the year ahead.
Today, the market trades at about 13 times forward earnings – which makes “a case for a limited upside in equity markets,” he said. (Mr. Vasic was let go from UBS on Thursday as part of a cost-cutting initiative that saw the bank cut 20 jobs in Canada.)
And there is always the prospect of a return of bad news from one of the financial world’s trouble spots. Europe’s debt crisis is being managed by policy makers, but it hasn’t been solved. The U.S. government’s borrowing limit needs to be raised again by May, and will again become the subject of intense political arguments. Fixing America’s large fiscal deficit will hurt growth.
Michael Hanson, the senior economist at Merrill Lynch, says he’s concerned about the impact of the expiration of the U.S. payroll tax cut, one measure already taken to narrow the fiscal gap. His firm is modelling a 5 per cent decline in disposable income and consumer spending growth of just 0.5 per cent in the first quarter.
“The market has probably decided the various policy risks weren’t that big a deal, and not until they see the pain will they react. But I think in the first quarter, we will.”
Indeed, it may take only a handful of negative reports to cause investors to rethink their new-found optimism. Ian Aitken, managing partner with Pembroke Management Ltd. in Montreal, says the prevailing psychology of most investors is still negative. The memories of the crash may be fading, but they haven’t been forgotten.
“We aren’t expecting a return to a very ebullient time,” he says. “They don’t even need to become positive. They just need to become less negative.”
THREE REASONS TO BE BEARISH
1. U.S. political leaders can still mess things up
The country’s debt ceiling debate will start again as early as May, and House Republicans have said any new taxes are “off the table.” Brinksmanship akin to the August, 2011, debt-ceiling debate, which nearly led to a U.S. default, could shake global confidence in the country.
“Will we be any closer to a long-term resolution to debt limit by May 19? It doesn’t seem that way to me,” said Michael Hanson, senior economist at Merrill Lynch.
2. Corporate profits could stall
U.S. companies posted record margins in 2011, aided by depressed wages and low costs of borrowing; both of those factors seem poised to reverse. Analysts expect first-quarter profit growth for companies in the Standard & Poor’s 500 to average just 1.74 per cent in the first quarter before picking up later in the year; but of companies that have issued guidance for the first quarter, nearly three-quarters have come in under analysts’ numbers.
“Additional profit growth from here will, I think, be pretty hard to come by,” Mr. Hanson said.
3. Stocks may not be expensive, but they’re not cheap
The S&P 500 is up 127 per cent from its March, 2009, bottom and nearly 20 per cent from its 52-week low.
George Vasic, former Canadian equity strategist for UBS, said that in this time of peak corporate profit margins and a projected low-growth environment, a discount from the long-term average forward P/E of 14.5 is appropriate. He suggests 13 – which is about where the market is today. “Our view is there’s only a case for a limited upside in equity markets.”
THREE REASONS TO BE BULLISH
1. Investors could develop a new appetite for stocks
Retail investors have been pulling money out of stock mutual funds since 2007.
“In the U.S., people are still buying bond funds at a very healthy pace,” says Vincent Delisle, equity strategist for Scotia Capital. “Are we seeing the typical shift that confirms euphoria and the peak of the markets? No. We’ve just barely ended – maybe – a long stretch of redemptions for equities, and we’ve yet to see money get out of bonds.”
2. The U.S. economy is getting better – really
Most of the economic indicators reported in the past several months, from car and house purchases to employment numbers, have been heading in the right direction.
“House prices are bottoming and firming; there’s potential for their energy sector to do well; and the banking system appears to be more liquid, with credit growth generating job growth,” Mr. Vasic said. “There seems to be something stirring in the U.S. that looks sustainable over the next two to three years.”
3. A better economy may mean higher profits
Analysts expect revenues for the companies in the S&P 500 to gain 5.7 per cent in 2013’s first quarter, a higher rate than the expected 4 per cent for full-year 2012.
“When the economy picks up, you get higher revenues, and you get higher profits, because profit margins actually increase,” said Pierre Lapointe, head of Global Strategy & Research at Pavilion Global Markets Ltd. “What we’re seeing is an acceleration of the economy, and in that context, it’s very tough for us to be negative on equities.”
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