The Missing Man
By MICHAEL SANTOLI
THE STOCK MARKET HAS BEEN ON A ROLL for more than four years. The Dow has gained 27% just in the past 12 months. And, as financial television's play-by-play announcers endlessly remind us, the blue-chip indexes have hit "New All-Time Records" in recent weeks, including a fresh Big Round Number for the Dow -- 14,000 at Thursday's close.
Sounds exciting, no?
But most Americans greet all the hoopla with little more than a shrug. The public simply is not enthusiastic about stocks, judging by what individuals are both saying and doing.
While overall stock-trading volumes have surged, due largely to the influence of big, active hedge funds, retail-investor trading activity has grown only modestly, and remains well below the fevered levels seen in the second half of the '90s bull market.
As the table of Charles Schwab client data below shows, the discount broker's customers steadily have shoveled more assets into their accounts, but they aren't trading these accounts at nearly the same pace as they did a few years ago. Further, while broad measures of margin debt have increased rapidly in the past year, this, too, seems largely a hedge-fund phenomenon: Schwab customers' margin borrowing is up just 4% in the past year, even as the indexes have surged 20% and more.
Net inflows into stock mutual funds have been a trickle for most of the past few years, in many months turning into outflows. This is true even if one includes the money added to hugely popular exchange-traded funds. The Bank Credit Analyst, a research firm, points out that household-equity positions as a percentage of broad money-supply measures have been stagnant since 2004, and are on par with levels from 1995 or 1996, despite today's significantly lower interest rates.
The UBS Investor Optimism Index, a sentiment gauge based on a monthly survey of affluent Americans conducted by the Gallup polling outfit, has increased from the despondent readings of early 2003. But today's readings are similar to those from 2001, when the bear market was accelerating and the economy was in a brief recession. This index quickly backs off to cautious levels whenever the stock market encounters a pullback of a few percentage points.
So what does it mean that the little guy is wary of stocks? And should we expect the public, after sitting out a lucrative run in which the S&P 500 has doubled from its 2002 low and the average stock has done even better, to start chasing equities? More practically, is it a good idea for the little guy who has shunned stocks to jump in now?
ON ONE LEVEL, the public's hesitance to pile aggressively into stocks is understandable. It can be viewed partly as an extended hangover following a once-in-a-generation party, the late-'90s bubble in technology and mega-cap stocks that drew the masses in just in time to sustain devastating losses.
So, charitably, one can say the little guy has learned his lessons, such as the virtues of asset allocation, diversification and professional investment advice and management. No one ought to expect a public mania to erupt that is commensurate with the wild, lottery-ticket, day-trading environment of 1999.
"Trading data [alone] is not at all a good proxy anymore for our clients' engagement with the markets," says Schwab spokesman Greg Gable, who cites customers' use of mutual funds and other means of getting broad equity exposure.
Jarrett Lilien, president and chief operating officer of E*Trade Financial (ticker: ETFC) -- who arrived at the online broker in the frenzied days of August 1999 -- says that in discussing the company's first-quarter results, "we talked about the retail investor having been more subdued than we had anticipated."
Still, he says, almost since the moment this bull run began in March 2003, "There has been a very steady, measured return to the market" by retail investors. Lilien points out that a sample portfolio of stocks commonly owned by E*Trade clients contains far more blue-chip names than it did seven years ago, and customers are using more risk-mitigating tactics like stop-loss orders and option hedges.
His analysis suggests a more sober, thoughtful, sophisticated retail investor is at work in these markets. But that's half the point: This bull market has yet to lure many of the more reckless, speculative investors, as most bull markets eventually do.
It's a fact that bull markets have life cycles that draw participation from different groups of investors as they proceed. The little guy, to put it nicely, is never early to the game. Reliably, though late, small investors do make their way back to stocks before bull markets finally end.
Richard Russell, the longtime market commentator and editor of Dow Theory Forecasts, described this situation in a note to his newsletter subscribers last week. "True, the little guy may be skeptical, he may be wringing his hands over the housing situation or the price of a dinner at his favorite restaurant or the cost of gasoline," he said. "But somehow the big picture, the stock-market boom, has eluded him. That will not last. The little guy will not forever resist the lure of the bull market. It's a question of timing."
One reason market handicappers are focused on whether and when the public will return to the market in a big way is that stocks arguably need another group of incremental buyers to keep rising. Already, the copious liquidity from share buybacks and leveraged buyouts has either peaked or been threatened by debt-market unease. The latter phase of a bull market usually sees retail investors and foreigners grabbing the baton for the final laps.
For sure, Americans have had other outlets for their profit-seeking, often speculative impulses. Flipping condos and building spec houses were the preferred trades in the five years or so that the housing market soared on easy money and animal spirits, before cracking last year.
Even when it came to investing in equities, those who poured money into funds have chosen overseas vehicles. And the fetishizing of hedge funds, with their tactical bent and long-short modus operandi, is also telling, as individuals dabble in shorting, call-option selling and other techniques that betray less than complete trust in the stock market.
Toyota captured today's investment culture in a commercial that has a mother asking her two adolescent sons what to do with the money they saved on a new car purchase. "I'm thinking hedge funds," says one, and the other adds, "How about emerging markets?"
Also from the anecdotal-evidence file, in the week when the Dow first touched 14,000, the prominent ad space on the back cover of Barron's shouted, "Short. And Simple," in highlighting the ProShares ETFs that let investors bet against the market.
One shouldn't dismiss the possibility that a generally dark public mood, after four years of war and bitter policy divides, also might be restraining the kind of optimism that emboldens heavy equity investment.
Several times a year for a decade, a Gallup poll has asked Americans, "In general, are you satisfied or dissatisfied with the way things are going in the United States at this time?"
The "dissatisfied" category has been above 60% since October 2005 and above 50% since January 2004. It was below 50% for the entire stretch of May 1997 to May 2001, and between January 1997 and May 2000 -- those fat years when the bubble was inflated -- the average dissatisfied reading was 39%.
Aside from the public mood, demographics might be restraining investors' affections for equities. As baby boomers, who helped power the democratization of stock investing in prior decades, pass age 60, they increasingly will emphasize safety and income.
Perhaps it's premature to expect average investors to ratchet up their interest in and exposure to the market when, from a broad perspective, all that's happened is that the big-cap indexes have made an arduous, seven-year round trip to the same territory.
Typically, aside from new highs in the indexes, some kind of coherent, beguiling "cover story" is necessary to capture the public's fancy, such as a belief that technology is remaking the world. Note that when the '90s bull market was as far along as this one is (nearly five years from the earlier bear-market low), the Netscape IPO came along to inaugurate all the messianic talk about the dot-com revolution.
Today, the global-growth boom could serve as a similar catalyst. But the bellwether shares for this trend -- steel stocks and commodity names and railroads -- somehow might not convey enough whiz-bang newness to dazzle the "buy-what-you-know" crowd. And the new economic revolution is manifesting itself through rising meat consumption in coastal China and faster car sales in Eastern Europe, not on Americans' desktops, the way the last one did.
THE LUKEWARM REGARD for stocks among the retail set has led some analysts to conclude that this bull market, mature as it is going on five years without a 10% correction, is not poised to end.
As Matthew Pugsley of the Bank Credit Analyst puts it, "One reason we remain cyclically positive on the broad market is that retail investors still have not participated. Instead, the public remains infatuated with global equities and corporate bonds. It is doubtful that the equity market would cyclically peak before the retail-investor enthusiasm for stocks had reached a more fevered pitch."
Lilien of E*Trade also believes that the gradual, risk-conscious way individuals have so far rebuilt their equity allocations bodes well for the durability of this bull market. In a sense, he's hoping that the stereotypical dumb money stays away rather than coming in to provide the bull's last upside lunge before dooming it.
This is a reasonable notion, though one could quibble that it's not as if individuals have fled from stocks. The 401(k) revolution has not been unwound, and most of those with plans continue to fund some stock investments.
Also, it's worth asking whether the flows into global stock funds -- the ones that have already surged the most -- do reflect an appetite for risk, just a preference for non-U.S. risk.
Sentiment among institutional investors doesn't offer the broad negativity that a good contrarian buyer might want to see before getting aggressively behind stocks. Mutual-fund managers are holding record-low levels of cash. The Market Vane and Consensus sentiment surveys of professional investors have consistently shown the pros to be bullish. This complacent optimism is offset by a large base of shorted stock and heavy defensive-put positions, owing to the huge hedge-fund cohort.
Tom McManus, market strategist at Banc of America Securities, makes a regular study of investor-fund flows. He has been saying for some time that he believes investors are not exhibiting fear of equities, but are "just bored" by big-cap U.S. shares when viewed against the sexier returns of emerging-market stocks, small-caps and commodities. Partly for this reason, he has favored the very large U.S. stocks that the herd, until recently, has shunned.
Investors who have remained on the sidelines as the S&P 500 has nearly doubled since early 200 and are wary of re-entering the game as it ends should be aware of a few things. One is that those corporate-bond funds that so many have been "hiding" in are likely no longer a great buffer against possible market difficulties. If stocks falter, it will very possibly be because the corporate debt market buckles.
Also, it's not early in the bull market. Hedge funds and the deep-liquidity environment have ensured that the average stock is not cheap. Any continuation of this bull market will rely heavily on expanding price-earnings multiples rather than raw earnings growth, corporate buybacks and merger-and-acquisition activity.
This means stocks are likely to be more volatile, even if some of the volatility is of the upside variety. We are at the point in this bull market when, in both the '80s and '90s, the market experienced a nasty "gut check" -- in the form of the '87 crash and the emerging-markets crises of both '97 and '98. In neither instance was it fun or comfortable. But none of those episodes meant the very end of the fun, either, and each case proved a good buying chance, with a couple of profitable years afterward before bear markets hit.
Should we get one of those late-summer swoons or fall debacles, it could just be the chance for the little guy to defy his reputation as the market's patsy.
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