Sunday, December 21, 2008

Stock Investors Lose Faith, WSJ

Stock Investors Lose Faith, Pull Out Record Amounts
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By E.S. Browning, WSJ | 21 December 2008

One of the hallmarks of the long market downturns in the 1930s and the 1970s has returned: Rank-and-file investors are losing faith in stocks. In the grinding bear markets of the past, huge stock losses left individual investors feeling burned. Failures of once-trusted firms and institutions further sapped their confidence. Many disenchanted investors stayed away from the stock market, holding back gains for a decade or more.

Today's investors, too, are surveying a stock-market collapse and a wave of Wall Street failures and scandals. Many have headed for the exits: Investors pulled a record $72 billion from stock funds overall in October alone, according to the Investment Company Institute, a mutual-fund trade group. While more recent figures aren't available, mutual-fund companies say withdrawals have remained heavy.

If history is any guide, they may not return quickly.

Individual investors arguably form the bedrock of the market. It's difficult to pinpoint how much stock they hold, because they own shares through mutual funds, retirement accounts and other vehicles. But once retirement accounts are factored in, individuals likely account for half or more of all U.S. stock holdings, according to data from Birinyi Associates in Westport, Conn. Investors' discomfort with stocks has been growing for years, since just after the 2000 selloff of dotcom shares.

"I don't have any confidence in buying any new stocks," says David Herrenbruck, a 52-year-old New York photographer at the peak of his ability to save and invest. Mr. Herrenbruck was a big believer in stocks in the late 1990s, but he was burned by the tech-stock meltdown. He has since moved much of his money to real estate, and he has recently invested in bonds and certificates of deposit. "If I have some cash lying around, it is going to be in CDs," he says.

From 2002 through 2005, investors put an average of $62 billion a year into U.S. stock mutual funds, less than half the annual level of the previous decade. Since 2006, investors have been pulling money out of U.S. stock funds at a [net] rate of about $40 billion a year. Such skittishness already promises to put a brake on the stock market's recovery, which could make it harder for companies to raise capital and could squeeze financial firms' profits. That, in turn, could delay the economy's emergence from the severe recession that began last year.

Individuals aren't the only ones who have become skeptical of stocks. Many of the buyers who pushed indexes to record levels this decade— including private-equity firms and hedge funds— also appear to be increasingly looking beyond stocks. College endowments and hedge funds, for example, have in recent years funneled more money into alternative investments such as real estate, commodities, art, and even farms and timberland.

Lessons Learned

There's no way to know how long individuals could stay away from shares. Their confidence could be restored more quickly than in the past, optimists say, pointing to policymakers' efforts to avoid repeats of the 1930s and 1970s. Federal officials have sought to stabilize financial markets by injecting hundreds of billions of dollars, slashing target interest rates for overnight loans to nearly zero, and announcing plans to buy up mortgage-backed securities. Also, today's individual investors are different than those of past eras. In the 1930s and 1970s, stock investing was the province of a minority of rich Americans. Now, thanks to 401(k) programs and other retirement plans, nearly half of U.S. families have stock holdings.

Some of the biggest nest eggs belong to baby boomers who are reaching retirement age. The market could receive a boost if many sidelined boomers, whose retirements could span decades, decide it is safe to shift sharply back to stocks. But if these investors believe their money will be safer stashed elsewhere for upcoming years, it could slow a market recovery.

Four-Decade Cycles

Peter Lush is among those steering mostly clear of company shares. The 61-year-old retiree in Georgia built up his retirement plan by investing in a fund that owned midsize stocks. Until recently, he says, he had much of his savings in a bond fund, and after corporate bonds took a hit, he moved the money into CDs. "Maybe now would be a good time to buy" stock, says Mr. Lush. "But I am scared, to tell you the truth."

Enthusiasm for shares has waxed and waned in long cycles, with previous flights from stocks occurring eight and four decades ago. In 1932, the Dow Jones Industrial Average— in those days a speculative index of relatively young companies— had fallen 89% from its 1929 high. The 1930s brought [rapid Cyclical] bull markets followed by bears, taking back gains and sapping investor confidence. [[Typical of the Secular Bear we were in then and now, since 2000.: normxxx]] The sustained troubles of the 1930s exposed scandals in speculative instruments.

So-called investment trusts used investor money and borrowed funds to buy high-flying securities, sometimes buying stock in one another. Of the 1,183 investment trusts and other funds that existed from 1927 through 1936, more than half had failed by 1937, a government study showed. Goldman Sachs, which sponsored three prominent funds that lost most of their value, saw its reputation damaged for years.

The Dow didn't return to its 1929 high until 1954. New York University financial historian Richard Sylla recalls that even in the 1950s, some people were so spooked by the Depression that they were storing money in jars in the basement. The stock recovery of the 1940s and 1950s became a speculative boom in the 1960s, marked by the so-called Nifty Fifty stocks that brokers said would rise for years. They didn't.

In 1966, the Dow flirted with the 1000 level, then shed 25%. That bull-and-bear pattern would repeat for 16 years amid [fairly severe] inflation and soaring oil prices. Investor confidence was hammered again.

There was scandal, too, including the early 1970s collapse of Bernie Cornfeld's mutual-fund empire, Investors Overseas Services, which at one point had assets of more than $2 billion. Mutual-fund data from that period show investors reacted much as they have in recent years. After a market peak in 1968, people began putting less money than before into mutual funds, Investment Company Institute data show.

By 1971, they were pulling more money out than they were putting in. From May 1972 through March 1980, total dollars in stock funds fell 42%. Mutual-fund executives worried that the industry might not survive. [[Business Week famously declared The Death Of Equities in its August 13th, 1979 issue.: normxxx]] Money started flowing in again in the 1980s, after the government encouraged broad market participation through 401(k) plans and other retirement programs. Individuals gradually embraced the idea of 'buy-and-hold' investing, helping to usher in the stock boom of the 1990s.

Pax Americana

With the Cold War 'over' and investments flowing across the globe, people [everywhere] believed they were in a long-running Pax Americana of world-wide prosperity and rising productivity. During the 1990s, investors added $1 trillion to mutual funds. The Dow Jones Industrial Average surged above 11000 in 1999, up tenfold from 1982. Owning anything but stocks looked foolish.

That confidence has been shaken by two bad bear markets in less than a decade. Between 2000 and 2002, the Dow fell 38% and the Nasdaq Composite Index shed 78%. This year's market collapse knocked 47% off the Dow in just over 12 months, returning stocks to 1997 levels. As of Friday, the Dow still was 39% off its 2007 record.

"The question is whether this series of very strong bear markets will cause investors to retrench as they did in the '70s," says Brian Reid, chief economist at ICI. "I think there will be some of that," he says, although perhaps not as bad as it was then. People in the investment business hoped ordinary investors would return in large numbers when the market began recovering late in 2002. But this didn't happen.

In 2001, 53% of U.S. households held stock or stock funds, which turned out to be a peak. Now, about 46% of families own stocks, according to a report published last week by the ICI and the Securities Industry and Financial Markets Association. [But t]he disaffection appears to be deepening. By the end of October, amid the most recent market collapse, retirement savers tracked by consulting group Hewitt Associates were sending 58% of their contributions to stock funds. That was down from 75% at the beginning of this year.

The decade's second bear market also brought big failures and scandals— the end of venerable investment banks [indeed, of all of those banks, amid some very suspect accounting practices and activities reminiscent of Enron], an alleged $50 billion swindle by Wall Street stalwart Bernard Madoff— to add to the collapses of Enron, WorldCom, and others from earlier in the decade.

"For many investors, this has been a glimpse into the abyss," says Terrance Odean, a finance professor at the University of California, Berkeley, who has studied the behavior of individual investors. "They have been told that if you save regularly for retirement and buy and hold, you will be fine. Now, people see a possibility that this will not be the case."

Weak Hands

The market has given Karin Kuder a good ride over the past two decades, but now she's through. Starting in 1989, Ms. Kuder contributed as much as she could to her retirement fund, up to 15% of each paycheck. In the 1990s, she chose aggressive stock funds, moving to a more conservative mix after the 2001 terrorist attacks. Early this year, even after she retired as a nurse at a naval air station in Jacksonville, Fla., Ms. Kuder still held 60% stocks and 40% bonds.

In March, she trimmed her stock holdings to 50% of her portfolio. In October, with her account down $40,000, she ran out of confidence.
"It was the only money I had," Ms. Kuder says. "I wasn't sleeping." She phoned her financial adviser and said she wanted to put all her money in a safe place. The adviser persuaded her to leave 20% in stocks and bonds, but the rest went to a five-year fixed annuity, similar to a certificate of deposit, guaranteeing 5.1% a year.

"You put in all those years, and it is just falling right away from you," Ms. Kuder says. "I was so fearful that I was going to lose everything."

When market analysts talk about who's buying and who's selling in times like these, they sometimes speak of "weak hands" and "strong hands". Weak hands bail out when the market declines, seeking what they see as safer havens. 'Strong hands' are committed to the market for the long term, buying shares at what may turn out to be big discounts. Right now, the market is being driven by the exit of these 'weak hands'. Lasting recovery will come when some of these weak hands— or the next wave of younger investors— step back in.

There are signs that even younger investors are growing more fearful of stocks lately. Risk aversion has been on the rise this decade among all age groups, according to last week's report from the ICI and SIFMA. Although it will be long before young people need to tap their retirement savings, the losses they've seen in the current bear market could temper their enthusiasm for stocks for years to come.

Bright Future

Harris Cohen, a 25-year-old project manager with Amtrak in Washington, D.C., opened an individual retirement account in 2001, when he was 18, and filled it with stocks he thought had a bright future, including Apple Inc. and Garmin Ltd. He bought mutual funds that invest in alternative energy companies and utilities. He didn't bother with bonds.

"I had a real good track record over five or six years, with increases from 10% to 20% a year," Mr. Cohen says. His portfolio has fallen about 40% over the past 18 months, he says.

In September, he began pulling back from stocks. Now, he has shifted his retirement savings to corporate bonds, a money-market fund and a few utility funds. He says he doubts he ever will view stocks the same way.
"Even if the market were to rebound and the economy were to improve, I would be very loath to invest entirely in stocks," Mr. Cohen says.

While investor confidence is low, there are signs that it may have further to fall.

In 2001, people's hopes for stocks were extremely high. Only 5% of those surveyed expected average annual stock returns in the coming decade to be 5% or less, according to University of Oregon Prof. Paul Slovic, whose company, Decision Research, conducts the surveys. Today, nearly one-third of those surveyed expect such stock weakness, reflecting the decline in investor optimism.

But there is a surprising amount of optimism left. More than half of the small investors surveyed still expect annual gains of 10% or more over the next decade— at, or above, historical averages. At some point, these optimists may be right. [But i]nvestors who jumped into the market at the height of the last love affair with stocks are still hurting.

A $10,000 investment in 2000, into a fund tracking the S&P 500 with dividends reinvested, would [today] be worth about $7,000, according to Morningstar Inc. Those who put $10,000 into the same index in 1982, at the end of the last decade of disaffection, would have more than $150,000. But see also this article within the quote within the quote by Peter Bernstein
Two Little-Noted Features Of The Markets And The Economy; and this article Stock Dividend Yields vs. Interest Rates: An 80 Year History at the blog Seeking Alpha.

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