Kristina Hooper, CFP®, CIMA® is head of investment and client strategies for Allianz Global Investors Distributors LLC. She has a B.A. from Wellesley College, a J.D. from Pace Law and an M.B.A. in finance from NYU, where she was a teaching fellow in macroeconomics.
If individual investors’ New Year’s resolutions were to get off the sidelines, then they’re off to a good start.
In 2013, investors have stepped out of cash and back in to stocks, which could be a turning point for equity markets and the economy. Or it could be a sign that we’re due for a correction. Either way, a return to risk assets—particularly dividend-paying stocks—is a smart way to outrun inflation and stay on track to meet long-term financial goals.
Stocks rose again in the second week of 2013. The S&P 500 was up 0.43% for the week and 3.28% for the year, following on a gain of 16% in 2012. It seems like we may be headed for another year of “business as usual” for the stock market, which has produced gains of varying sizes in the last four years.
But what’s not usual is that finally retail investors are acting more like their institutional counterparts by increasing their exposure to equity mutual funds. We saw significant net inflows into equity funds by individual investors last week, reversing a longstanding trend. According to Bloomberg News
, citing EPFR Global, $22 billion flowed into equity funds invested around the world last week, which is the second biggest inflow into stock funds since EPFR began reporting flow data in 1996. Interestingly, we still saw substantial inflows into fixed-income funds, suggesting that the assets deployed into stocks came from cash and cash equivalents.
And the CBOE Volatility Index (VIX) has been behaving unusually of late. It finished at 13.49 on Friday, below the 22 level it saw in late December and far below its historical average for the past five years. Consider that the 52-week range for the VIX is 13.22 – 27.73. It hit its 52-week low of 13.22 last week, marking the lowest volatility since June 2007.
Perhaps even more unusual is that, even though the popularity of stocks and stock funds among retail investors is a very new “trend,” a number of strategists are already arguing that we are at a market top. Some strategists have cited the American Association of Individual Investors Poll, often viewed as a contrarian indicator, which showed that bullish sentiment last week rose 7.7 percentage points to 46.4%, which compares favorably with its long-term historical average of 39%. Others have focused on the fact that the biggest-ever inflow of money into stocks ($23 billion) occurred in the third week of September 2007, a month before the S&P 500 hit a record high. They have argued that last week’s inflows may be signaling that we’re due for a correction. Still, other market observers argue that the VIX is a contrarian indicator: if volatility is high, then people are overly scared and it’s a good time to buy stocks; but if volatility is low, then people are overly complacent and it’s time to sell stocks.
So why are so many people skeptical about the popularity of stocks among a broader group of investors? Perhaps because there are two macro issues on the horizon that have the potential to derail the stock-market rally: the debt ceiling and an end to quantitative easing. The fiscal-cliff deal left many issues unaddressed. While the future of all the expiring tax cuts has been resolved, the other component of the fiscal cliff—how federal government spending will be cut—has not been resolved. And Republicans are promising a big battle on this issue after what was viewed as a defeat for them on the tax-cut debate.
Further, we’re seeing more signs that the Federal Reserve may shorten its current round of quantitative easing, which is likely to create a headwind for investors. Not only did the FOMC minutes surprise many Fed watchers who had previously dubbed the third round of quantitative easing “QE Infinity,” but also several FOMC members are becoming more vocal about their dissent regarding the Fed’s current accommodative monetary policy.
However, maybe more investors are finally recognizing that the environment we are in and likely to stay in for a number of years—financial repression—requires a re-allocation of assets. Financial repression, where interest rates are held artificially low to produce real rates that are below GDP growth in order to erode government debt, has created a very different set of risks than the ones investors faced five years ago. Financial repression is particularly dangerous for investors with large allocations to cash and core fixed income. However, stocks—particularly dividend-paying stocks—are an important solution for most investors. That’s because extremely low interest rates compress the yields on many cash instruments and core fixed-income investments, producing negative real returns. Meanwhile, risk assets such as dividend-paying stocks offer positive real yields and the potential for capital appreciation that can outpace inflation.
No matter what the outcome of the debt-ceiling debate or the duration of quantitative easing, all investors with long-term goals need to focus on asset classes that can generate positive, inflation-adjusted returns and growth at a time when growth is scarce. Individual investors seemed to take a step in the right direction last week by taking cash that is likely earning a negative return off the sidelines and putting it back into stocks. Let’s hope it reflects a more prudent game plan and not another bout of performance chasing.
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