The Sourpuss Stock Market

November 18, 2011

The U.S. stock market's recent sharp rebound puts it almost exactly where it ended 2010. Unfortunately , foreign stocks have not fared as well. They'd have to rise more than 15% just to get back to where they were at the beginning of the year.

As of November 14th, the S&P 500 is down a fraction, but up about 1% if you include dividends. In other words, despite the U.S. debt ceiling battles, euro debt chaos, and slow economic growth blues, investors are still beating money market funds and CDs. Granted, CDs don’t fall nearly 20% in a few weeks, look like they're going to slide another 50%, and then  recover. Such is the new market: low returns, sky-high volatility.

In the past, October's roughly 14% run from the bottom would have caused some performance-chasing money to rejoin the stock market party. Typically, positive returns lead to inflows, and negative returns lead to mutual fund outflows. But this time around, the outpouring of money is as firmly in place as the inflows were in the late 1990s. The money didn’t stop going into funds in 2000, even as stocks began their long slide downward. Investing in stocks was ingrained as a good idea. Today, not so much.

U.S. stock funds are losing between $10 and $15 billion each month in steady weekly withdrawals, while foreign fund withdrawals have stabilized in recent weeks. Bond funds are still experiencing big inflows. Muni bond funds are not seeing big inflows, even though they're near 52-week highs. Thanks to the predictions of one well-known market pundit, investors still anticipate some sort of cataclysmic default this year . People appreciate predictions that appeal to what their gut thinks, anyway. 

There's a variety of reasons for the withdrawals from stock funds. The market is not crummy enough to warrant the steady outflows. So why are investors giving up on stocks? 

Some people don’t enjoy amusement parks. Maybes it’s all the screaming kids. After  an exciting, yet nerve-wracking ride, you find yourself back where you started, and unsteady on your feet. No need to try that again for a while. 

Some simply need to throttle down the risk as they age. Unfortunately, they're shifting into bonds and cash with near-guaranteed low returns for the next 5 – 10 years. This baby boomer shift is probably not a driving factor in the outflows of recent years, but it may an increasing drag going forward.

Some are spending down retirement savings because they've lost income in the slow economy. This drag probably isn’t that big on stocks, but could result in a few billion a month (in theory.) Keep in mind that although there are about seven million more unemployed people now than there were before the recession, only a subset of this group had stocks to sell, and there are ten times as many still saving in 401(k)s, IRAs, and taxable accounts that would eclipse this drag. That's why Fidelity found that at the end of 2010, 401(k) balances were at ten-year highs. Bond funds are also seeing inflows.  liquidating retirement portfolios to make the mortgage payments would not just hit stock funds.

Right now, negativity is the primary driver, not actual cash needs or reduced risk tolerances due to age. A more recent survey by Fidelity of higher net worth investors reads like a survey of the terminally pessimistic. Findings include:

  • European Debt to Have Lasting Impact – Sixty-five percent believe that the European debt crisis will impact the U.S. equities market for at least a year.
  • S&P to End Year Flat or Down With Ongoing Volatility – Nearly two-thirds (65 percent) said they believe the S&P 500 is going to end the year either flat or down. Additionally, 80 percent expect market volatility will be the norm for the extended future. 
  • Low Interest Rates Reduce Income – Eighty-two percent of respondents said historically low interest rates were reducing their investment incomes.
  • Jobs Key to Economic Recovery With Double Dip Likely – Nearly three-quarters (73 percent) said a large drop in the unemployment rate is needed to spur strong economic growth, but 64 percent said a double dip recession is likely or already here. 
  • Tax Increase Concerns – Potential income tax increases were the most concerning for respondents (39 percent), with capital gains tax increases second (28 percent).

And this is a survey of "affluent investors". Makes you wonder how sour the not-so-affluent investors are feeling about the future.

Keep in mind people (and experts) tend to be wrong about the financial future. Back in 2005, most thought home prices would go up much faster than long-term historical averages for the foreseeable future. In 1999, they thought stock prices would go up by yearly double-digits forever. Based on the S&P prediction alone, there's probably a 65% chance stocks will be up by year's end, proving most of these people wrong.

The only problem with second guessing negativity is this: negativity can be a self-fulfilling prophecy. If enough people believe stocks are going down, and enough money comes out, stocks will  go down. At least for a while – until there isn’t much more negativity money to move out, at which point that much bigger of a rebound will eventually begin.