By Alexander Green, Investment U Chief Investment Strategist
Here's a brainteaser for you. Does the chart below represent:
A. a bull market
B. a bear market, or
C. a flat market?
If you answered A, congratulations. You can skip that visit to LensCrafters. Your eyesight appears to be normal.
But if you trust the old saw that "seeing is believing," why don't the vast majority of investors understand that we're in the midst of a rip-snorting bull market? After all, the chart above is a depiction of the S&P 500 over the past three and a half years.
Most investors simply don't accept that we're in a bull market. (Or they insist it will end at any moment.) They don't believe the trend is their friend. I hear this from former colleagues on Wall Street all the time. They say investors are still scared to death and sitting on their hands.
This is only anecdotal evidence, however. Let's look at something more conclusive, like mutual fund cash flow figures. These numbers show whether mutual fund investors are buying or redeeming shares of equity funds. And they have a strong correlation with stock market performance. Not in the way you might think, however. History shows fund shareholders tend to be heavy buyers near market peaks and heavy redeemers at market bottoms.
And investors ? who cashed out in droves at the market bottom a few years ago ? are still yanking their money out of the market today. According to Lipper, equity funds reported net outflows totaling $1.297 billion the last week of September.
Why all the pessimism when the vast majority of stock prices are heading higher? The first obvious reason is that many investors were badly burned during the financial crisis. That has a decidedly dispiriting effect and tends to leave scars only time can heal.
Another reason is this is a political year and the airwaves are full of negative commentary and ads. Romney argues that we need to change Obama's failed policies. Obama argues that we can't return to the failed policies of the past. There's not a lot here for an optimist to hang his hat on...
Why the Markets Continue to Rise
Still, the market marches higher. Why? Here are just a few good reasons: low inflation, zero interest rates, record corporate profits and record profit margins. I might note that valuations are low, too. Over the past 50 years, the S&P 500 has traditionally sold for an average of 16 times trailing earnings. Today it sells for just 13 times trailing earnings.
Most investors don't care. They're licking their wounds and sitting in cash, watching their money compound at a less-than-salutary five one-hundredths of one percent.
This is the most disrespected bull market in history. More people believe in Bigfoot than this market. And that attitude almost certainly means that ? barring some exogenous event like financial contagion in the Eurozone or Israel bombing Iran ? stocks have further to run. Bull markets don't generally end until everyone is on board. And we're certainly not there yet. So stay invested.
Eventually, of course, investors will get sick and tired of low yields and begin moving money into the market again. At first it will just be a trickle. Then the trickle will become a stream. Eventually, the stream will become a river and finally a flood.
Then it will be time to watch out, because the down cycle will return. Just as every bear market is followed by a bull market, every bull market is followed by a bear market. That's just the way things are.
As Mark Twain famously said, "History doesn't repeat itself, but it does rhyme."