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As Market Optimism Grows, Is It Time to Get Out?

Dario Cantatore | Getty Images

Mom-and-pop investors may be coming off the sidelines just as the pros are ready to take a breather, setting up a dicey start for 2013.

Sentiment surveys indicate a frothy level of enthusiasm for a stock market that weathered a series of storms this year, and the Standard & Poor's 500 looks set to close with gains of better than 12 percent.

But when regular investors get excited, bad things often follow.

Retail investors are notoriously late to the market party, buying high and selling low. They stay on the sidelines until the storms pass, and by then it's usually too late to reap the gains of a market rally.

"That's definitely a concern. Sentiment polls are starting to reach high levels of excitement toward equities," said Ryan Detrick, senior technical strategist at Schaeffer's Investment Research in Cincinnati. "From a contrarian point of view, that's clearly piqued my interest."

Among a slew of other strongly bullish indicators, the National Association of Active Investment Managers' survey this week showed a stunning 88 percent allocation to equities, a 33 percentage point increase just since the end of November.

Active managers have been faring poorly for the past few years amid rising correlations across the financial markets. About 40 percent continue to underperform their benchmarks as the year draws to a close.

Their excitement about stocks, then, could give pause about where the market is really heading. (This report in September, The Great Investing Dilemma: 'Always Late to the Party,'" also warned about retail investors coming in late. The market has fallen nearly 4 percent since.)

"We continue to think it prudent for investors to consider taking at least some profits in positions with outsized gains," John Stoltzfus, Oppenheimer's chief market strategist, said in a cautionary note to clients. He recommended that investors hold onto those gains and use them to buy dips in "equities, particularly high-quality, dividend-paying stocks with cyclical exposure that have the potential to produce capital gains."

Indeed, pulling some money off the table as retail investors change course seems to make some sense.

After all, Wall Street's earlier optimism that the "fiscal cliff" negotiations in Washington would yield some palatable deal now seems misplaced, keeping the market in a tight trading range for December and causing a precipitous fall Thursday. (This mid-November report asked: Are Investors Actually Taking the 'Fiscal Cliff' Too Lightly?)

"It is prudent now to wait. The issues are far deeper when it gets down to the nuts and bolts of the plan to go in at this point and be complacent," said Quincy Krosby, chief market strategist at Prudential Annuities in Newark, N.J. "The uncertainty is weighing on investment decision-making. It isn't as if investors don't want to go in and invest. But they need clarity on the backdrop."

Some investors, though, have chosen to jump in regardless.

Exchange-traded funds with stock exposure saw inflows of about $25 billion over the past month, the highest in two years, according to TrimTabs. While ETFs often are thought of as the realm of institutional investors -- 401(k) retirement programs, for instance, do not include them -- more on the retail side are getting involved.

Bullishness on the American Association of Individual Investors survey has hit a 10-month high, and TrimTabs said money is coming out of short ETFs that bet against the market.

Thomas Lee, chief market strategist at JPMorgan, advises a short-term beta chase -- looking for beaten-down stocks that have fallen below their 200-day moving average and have low price-to-earnings ratios. Among his picks are FedEx, Dell, Boeing and Staples.

"Ultimately, we see the S&P 500 finishing the year strongly. And, arguably, this should carry into January/February of 2013," Lee said in a report. "However, we caution that this is also the cause of potential downside risk in (the first half). That is, we see the beta chase turning into a beta 'beat-down' in the Spring."

Krosby said it's worth noting that the market's strongest performers recently have been cyclical rather than defensive names, which she said is probably indicative of longer-term strength despite the near-term worries over sentiment.

"There's a growing sense that if there is no (fiscal cliff) deal, or if the deal is not enough to assuage market fears, then you are going to see a big amount of selling," she said. "If that happens, the market will provide bargains."

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