Santoli: Investors making mistake tuning bull out

Published Mon, May 23 20165:16 AM EDT

Maybe it's faint, and many would say far-fetched, but there's a case to be made for stocks moving nicely higher. Investors, though, seem uninterested in hearing it. Withdrawal of money from equity funds is no longer a reflex in response to sudden market drops, but something like normal, default behavior. Another $5.8 billion left stock mutual funds and exchange-traded funds in the latest week, according to Merrill Lynch, the sixth-straight week of outflows, all coming with stocks stabilizing a few percent from all-time highs. The tally for the year: $96 billion withdrawn from equity funds or roughly 1.3 percent of assets under management. About two-thirds of that total have been added to bond funds. Certainly, there's a demographic currently drawing money from the stock market as baby boomers retire. But stock ownership is so concentrated among the very wealthy who don't need to clip coupons that this shouldn't be the dominant force. And, in any case, others are not adding to equities in large enough numbers to offset this pull. Those who remain in the market are increasingly huddling toward what they believe are its "safer" nooks. Among Merrill's vast wealth-management clientele, holdings of "low-volatility" ETFs have surged by 60 percent this year, followed by similar "quality-stock" funds, then precious metals, utilities and inflation-linked Treasury products. This all points to the average investor being more afraid than greedy. An Eaton Vance survey this spring found that 81 percent of financial advisors said their clients were motivated by fear, up from 72 percent a year earlier. Almost two-thirds believe their clients view market volatility more as a risk than opportunity. We can see something like this mindset in the weekly poll by American Association of Individual Investors. Last week, only 19 percent professed bullishness on stocks for the next six months, the lowest proportion since the February market panic. More obscure, but also worth tracking, is the action in popular volatility-trading products. The prevailing pattern in options, futures and funds pegged to the CBOE S & P 500 Volatility Index shows betting skewed toward a more hazardous market a few months out, while the surface of the market remains calm with the spot VIX currently near the tame 15 level. Those who study these relationships view them as bullish for stocks, all else being equal. This is not all presented to argue that this is, in the once-descriptive but now irritating phrase, "The most hated bull market." It's not really hated, and (who knows?) might not even still be a bull market. Investors are still plenty involved in stocks, if only because their value is up a lot in recent years. The AAII asset-allocation survey has members reporting their equity allocations still above 60 percent. The pros who try to ride the market wave are participating: The Consensus Inc. weekly poll of traders shows 71 percent bullish. This reading is a bit of an outlier versus other gauges, but cannot be dismissed. Rather, most evidence points to public indifference toward stocks and very little perceived risk that the market will run higher without them owning enough stock. As with all social trends, this one is rooted in some rational judgments. U.S. stocks have gone nowhere in more than a year and a half, and globally there has been far more pain than gain. The Standard & Poor's 500 index closed Friday at 2,052. It's been within 10 points of the 2,050 level in more than 40 percent of all weeks since October 2014. Stocks look at least fully valued, with profits having stalled since 2014. There's a growing chance the economy is doing well enough to prompt another Federal Reserve rate boost but not growing fast enough to lift earnings. There is a scarcity of safe income in the world. We got two separate 10 percent corrections in six months with few satisfactory explanations for what, exactly, triggered them. So what, then, is this rumored bullish case that folks are mostly tuning out? It starts, mischievously, with the very fact of all this collective skepticism toward stocks. Markets, if given the chance, tend to confound a comfortable consensus, so sentiment is at least a modest tailwind. On the fundamental front, earnings have been not quite as poor as forecast, and corporate guidance on the rest of the year is also less bad than usual. It's at least plausible to pencil in a return to modest profit growth in the third quarter. On valuation, there's no doubt stocks are priced near the upper end of their historical range and are priced for subpar long-term returns. The bullish take: In a world where government bonds elsewhere are trading at negative yields and have become more "expensive" than ever before imagined, and with high-grade corporate bonds near 3 percent, and commercial real estate at skyscraping valuations, what's to stop stocks from getting even more expensive? Liquidity conditions, for now, seem "good enough." High-yield debt-risk spreads have narrowed impressively, substantiating the recovery. Capital markets remain accepting, with heavy corporate-debt issuance and Tesla Motors selling more than $2 billion in stock at a sturdy price in one day last week. None of this will likely sway the skeptics. They can point out the rally looks technically precarious, that the Fed and politics can easily spook this market. Some might also mention that investors weren't exactly in love with the stock market in late 2007 either, and the junk market even rallied with stocks in the spring of 2008, ahead of disastrous times. Fair enough. But risk-minded investors might also want to pause to at least consider "upside risk" as well. Among sectors, most of the noise in financial stocks has been about "trading the next Fed move" in the banks, insurers and discount brokers that would earn a few more bucks if short-term rates got another bump or two. It's been a tough game, with constant switchbacks and little analytical edge to be found. CME Group , though, is a decent play on financial uncertainty itself, parent of leading derivatives exchanges that effectively earn a fee on the traded hopes and fears of the world's investors. Interest-rate futures and such remain the leading product area, though the company is nicely diversified across asset classes and global regions. The shares aren't cheap at 23 times 2016 earnings, but it's a fabulous business with 60 percent operating margins, a legally sanctioned casino becoming ever-more central to post-crisis capital markets tilting toward listed, centrally cleared derivatives trading. The stock has been tacking sideways between $90 and $100 this year in a constructive way as we all await the Fed's next move. At the other end of finance, Capital One Financial is a cheap card issuer, around nine-times earnings, that should benefit from increases in consumer credit balances and stronger household finances. The stock recently surfaced in a screen by BMO Capital Markets for underappreciated stocks that look inexpensive versus the company's growth rate. The shares, at $70.93, are up 18 percent from February's low but have work to do to approach last summer's highs above $90. The good news is, analysts are cool on it, so it remains a better-acting stock that might appeal to contrarians.

Traders work on the floor of the New York Stock Exchange (NYSE) in New York City.

Brendan McDermid | Reuters

Maybe it's faint, and many would say far-fetched, but there's a case to be made for stocks moving nicely higher. Investors, though, seem uninterested in hearing it.

Withdrawal of money from equity funds is no longer a reflex in response to sudden market drops, but something like normal, default behavior. Another $5.8 billion left stock mutual funds and exchange-traded funds in the latest week, according to Merrill Lynch, the sixth-straight week of outflows, all coming with stocks stabilizing a few percent from all-time highs.

The tally for the year: $96 billion withdrawn from equity funds or roughly 1.3 percent of assets under management. About two-thirds of that total have been added to bond funds.