Investors love to fantasize their decisions are based on logic and foresight. But by using inconsistent arguments, investors have fooled themselves yet again, and created what I call the "Great Paradox."
For example, stocks have become the Rodney Dangerfield of investments: They can't get no respect. Despite corporate wage addition 125 percent since 2009, many investors remain skeptical of the outlook for stocks. Bloomberg News reported recently that valuations for U.S. Equities have been stuck in a remarkably long-running slump that hasn't responded to this surge in profits, suggesting that investors don't trust the growth to continue.
That lack of trust is clear in the low Price-to-Earnings (P/E) ratio of the S&P 500, currently less than 13 times the 2012 wage forecast. Compare that to the midpoint historical P/E ratio of 16.4 times. If investors valued associates in the S&P 500 according to the historical midpoint P/E, the S&P 500 would be 30 percent higher. But no such luck.
Corporations proved their flexibility and adaptability during the Great Recession. Corporate profits have been very strong, rebounding much faster than Gdp. Corporations now run leaner than they did a few years ago and will benefit greatly from any economic tailwind. Yet many remain skeptical that this behalf resurgence will be sustained.
On the other hand, bonds have performed extraordinarily well in recent years - so well, in fact, that many (myself included) see microscopic remaining upside. There's not much of in any place for long-term bond prices to go other than down, since those values run directly inverse to interest rates, which are currently nearly as low as they can be. Meanwhile, despite a worsening fiscal government outlook, U.S. Treasury bonds have done so well over the last 30 years that they have outperformed stocks. The last time that happened was prior to the Civil War.
Still, investors have poured billions into bond mutual funds over the last five years, and have removed billions from stock mutual funds. according to data aggregated by TrimTabs, investors have removed money from U.S. Stock mutual funds in each of the last five years, along with approximately 0 billion last year alone. Meanwhile, investors have added money to bond mutual funds in each of the last six years, along with more than 0 billion into bond mutual funds last year. Investors seem to think that bonds will continue to appreciate indefinitely; at the same time, they distrust that current corporate wage will continue. They have fallen into the Great Paradox.
Call me crazy, but I believe fundamentals matter. As Warren Buffett observed, "In the short term, the store is a popularity contest. In the long term, the store is a weighing machine."
There's no suspect to think stocks won't achieve well in a slow-growth economic environment and even good in a good environment. And unlike for bonds, being a strong performer isn't an anomaly for stocks. For those with a sufficiently long-term perspective, clinging to bonds isn't a position that makes sense. As Jeremy Siegel, finance professor at the University of Pennsylvania's Wharton School in Philadelphia, told Bloomberg News, "The rally in bonds is a once in a millennium event, but it's as a matter of fact mathematically impossible for bonds to get any kind of returns like this going forward whereas stock returns can repeat themselves, and are likely to outperform. If you missed the rally in bonds, well, then that's it." (1)
Why are so many habitancy tempted to keep favoring bonds and avoiding stocks, ignoring solid reasons to do the reverse? One suspect could be herd mentality. As my colleague Benjamin Sullivan observed, many investors supervene the crowd, buying overvalued stocks when the financial media and Main road are optimistic about the market, and shunning stocks when prices ebb, despite the fact that it makes more sense to buy low and sell high.
Think about it. Should you buy stocks when everyone thinks the world is ending - say in March 2009, when the S&P 500 complete as low as 677 - or when all is Pollyannaish - say in October 2007, when the S&P 500 complete as high as 1565?
Though the timing is difficult to pinpoint, one should to try to buy near the height of pessimism and sell or cut close to the height of optimism. As legendary investor Sir John Templeton once said, "Bull markets are born on pessimism, grow on skepticism, mature on optimism, and die on euphoria."
Investors may also be tempted to let past operation overly decree their expectations for time to come behavior. However, while it's smart to behold in the rearview mirror from time to time, looking only backwards and ignoring the path ahead will inevitably lead to messy smash-ups.
No one can forecast exactly what the store will do in the short term. But there's no suspect for the excessive pessimism that investors seem to apply only to stocks. This summer, Burton G. Malkiel, a professor of economics at Princeton, wrote in The Wall road Journal: "We have abundant evidence that the midpoint investor tends to put money into the store at or near the top and tends to sell out during periods of ultimate decline or volatility. Over long periods of time, the U.S. Equity store has provided kind midpoint every year returns. But the midpoint investor has earned substantially less than the store return, in part from bad timing decisions." (2)
Uncertainty is frightening, and it isn't surprising that investors are tempted to cut and run at the first sign of trouble. Investors have clearly lost trust in stocks in recent years. But post-recession, it seems many investors have gone a step farther than caution. I suppose two bear markets during the same decade are adequate to make investors jumpy. Meanwhile, investors pile into a bond store with microscopic upside and considerable downside.
Warren Buffet made the following analogy: "I'm going to buy hamburgers for the rest of my life. When hamburgers go down in price, we sing the 'Hallelujah Chorus' in the Buffett household. When hamburgers go up, we weep. For most people, it's the same way with all in life they will be buying - except stocks. When stocks go down, you can get more for your money, but habitancy don't like them any more. That sort of behavior is especially puzzling." It's not only puzzling; it's costly.
Hockey legend Wayne Gretzsky put it best when he said, "I skate to where the puck is going to be, not where it has been." The puck has spent the last five-, 10-, and 30-year periods production money for bond investors. I suspect the next five, 10, and 30 years are going to be in stocks' end of the rink.
Sources:
1) Bloomberg, "Say What? In 30-Year Race, Bonds Beat Stocks"
2) The Wall road Journal, "Don't Panic About the Stock store "
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