It scarcely needs mentioning that the stock market is merciless and unpredictable. Its gyrations make fools of financial gurus and promise a world of hurt to anyone who thinks they’ve figured out how to outsmart everyone else. Nope, there’s nothing one could ever hope to predict successfully about the stock market. Well, except for this: mom and pop investors will always be late to the party and miss out on the big gains.
Unless you’ve been hiding in a bunker, you’re no doubt aware stocks are on a rip-roaring tear. Or maybe, like many, you’ve ignored it and are only now tuning in to our regularly scheduled bull market. You wouldn’t be alone. Since bottoming out in March 2009, the Canadian and U.S. markets have climbed between 85 and 170 per cent respectively. Sure, there were bumps along the way—hey, remember that time Europe almost collapsed!?—but for those investors who didn’t panic and sell during the financial crisis, or better yet, seized an opportunity to buy stocks cheap, the past five years have been, hands down, the greatest opportunity for wealth creation in modern history. Individual investors have sat on the sidelines for pretty much the whole time. Is it any wonder shrewd money managers view households as the ultimate contrarian indicator of where markets are headed? As Warren Buffett is fond of saying, when the mood of crowds is at its darkest, that’s the time to buy; when the masses are in a trading frenzy, run for the exits. Which is exactly why many forecasters are starting to get nervous about the rush of households returning to the markets. Headlines in the financial press and market blogs over the past year have trilled the return of retail investors. Yet those fears, for now at least, are completely unwarranted.
There’s no question retail investors—as opposed to the institutional type, such as hedge funds, pension funds, banks and insurance companies—are pouring their money back into the market. In Canada, individuals have, for the past six months, bought far more equity mutual funds (meaning funds that hold stocks) than they sold, the longest positive streak since before the financial crisis. In the last quarter of 2013, net sales of equity funds topped $3.6 billion. With RSP season upon us, some analysts expect we’ll see that amount swell.
An almost identical trend has been under way in the U.S. After pulling more than $400 billion from equity funds during and after the crash in 2008, Americans have sunk roughly $120 billion back into those funds over the past year. Meanwhile a regular survey conducted by the American Association of Individual Investors shows people are putting more of their money into stocks, versus other types of investments, than they have in six years.
It’s also undeniable that most individuals make horrendous investment decisions when trying to time the markets. In a new report, Nuveen Asset Management calculated the annualized returns, from 1992 to 2011, of various assets like real estate, stocks and commodities. While the S&P 500 stock index returned an average of 7.8 per cent a year over that time (including the 2008 crash), individual investors who actively jumped in and out of the market achieved a lousy annualized return of just 2.1 per cent per year. They didn’t even keep up with inflation.
But it’s wrong to conclude that the return of retail investors means markets are in a dangerous bubble zone. For one thing, even though Americans are scrambling back into funds, they’ve largely missed the market that’s mattered most—their own. Figures from the Investment Company Institute show that less than 25 per cent of the money flowing into equity funds has gone to those holding U.S. stocks. The S&P 500 may have soared more than 30 per cent in 2013, but there were only five months when domestic stock funds attracted more investors than they los. Americans simply haven’t bought into the idea that their economy is on the mend and that this bull market is for real.
In Canada the flow of money back into mutual funds also has to be put in context. In one single month in the fall of 2008, as markets cratered, Canadian investors yanked more than $8 billion out of funds. There remains a mountain of investor cash sitting fearfully on the sidelines of North American markets. Investors have a long way to go before their purchase of stocks can be considered frenzied. Trying to claim they are a sign of a bubble misses the mark.
The funny thing about bubbles is they’re almost impossible to spot when you’re floating within their shimmering confines. Bubbles by their nature require most people to be oblivious to their existence, and more focused on whatever “new-era story,” as the Nobel economist and professional bubble-spotter Robert Shiller calls them, is driving markets. When everyone thinks there’s a bubble, there probably isn’t.
At one point, Canada was in the grips of one of those new-era stories—that because we weathered the financial crisis so well, our economic exceptionalism made us the envy of the world. Foreign retailers like Target flooded across the border to serve consumers here, while several American investment firms opened shop to capitalize on our more affluent citizens. But now, with the loonie in free fall and foreign economists fretting openly about our housing market, you don’t hear that claim much these days. As Elvis Picardo, a strategist at Global Securities in Vancouver, wrote in a recent report, “Canada’s golden period has indeed drawn to a close.”
That’s actually a good thing as Canadian investors tiptoe back into stocks. The fact is, in a 24/7 financial news cycle that blares each new stock market high, it’s easy to forget how poorly Canada’s S&P/TSX has performed over the past few years. After closely matching the S&P 500’s recovery starting in March 2009, the American index began to pull away in the fall of 2011 when commodity prices began to weaken. Since then Canada’s resource-heavy stock market has risen by little more than 10 per cent. At the same time the S&P 500 has skyrocketed more than 50 per cent. (Neither figure reflects reinvested dividends.) In the past couple of decades there has never been a time when Canadian stocks lagged the American market for so long at such a wide margin. This puts Canadian investors who enter the market now in a better position from a valuation perspective: relative to earnings, the S&P/TSX is slightly cheaper than the S&P 500. “Canada has more elbow room,” says Benjamin Tal, deputy chief economist at CIBC World Markets. “Canada will be playing catch-up in 2014 with the U.S.”
Could stocks crater again? Of course they could; they always do. Over the past five years the S&P 500 has suffered two corrections in which stocks dropped roughly 20 per cent, not to mention multiple other corrections of between five and 10 per cent. Eventually, there will be a far more significant crash. It’s unavoidable.
But stock market fluctuations are normal. That’s why trying to time the markets is so perilous, and why sitting on cash and wondering if you’ve missed the bull run will almost assure that you do.