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This bull market might not be hated, but it still isn't trusted

  • Surveys show professional investors are largely bullish and are refusing to fight the sturdy tape.
  • Yet Main Street's faith in stocks is fragile, with the latest American Association of Individual Investors poll showing just 24 percent bullish on equities.
  • Strategists like to think we can't have a market top without small investors fully involved, but that isn't necessarily the case.
A statue of a girl facing the Wall Street Bull in the financial district in New York.
Brendan McDermid | Reuters
A statue of a girl facing the Wall Street Bull in the financial district in New York.

Hate, as your mother probably told you, is a strong word, and it no longer seems to capture the public's attitude toward stocks. Yet the typical investor still doesn't quite trust this market, feeling wary of its heights and suspicious of its foundations.

The way this mistrust plays out from here will be a big factor helping to determine how long and far the bull market can carry on.

Investor ambivalence can be glimpsed from a few angles. The monthly Bank of America Merrill Lynch global fund manager survey shows a record percentage of pros see a "just right" investment backdrop of strong growth and low inflation. Yet those calling stocks "overvalued" is also near record highs, and cash levels remain above average — hints of caution tempering the optimism.

Yale economist Robert Shiller has surveyed professional and amateur investors for decades about their market expectations. Right now, both groups' confidence that stocks will rise over the next year is near a multi-decade high. Yet the counterpart "Buy the Dips" and "Crash Confidence" indexes show elevated anxiety that the good times could end suddenly and painfully.

Other surveys show a fairly familiar pattern, with professional investors (tracked by Investors Intelligence, Market Vane, National Association of Active Investment Managers) largely bullish, refusing to fight a sturdy tape, while Main Street's faith in stocks is fragile, with the latest American Association of Individual Investors poll showing just 24 percent bullish on equities.

Source: www.aaii.com

The movement of real investor cash conveys mixed messages of its own. Flows into stock funds have been uneven, with net withdrawals over the past three weeks as the market stalled near record highs. And when money does go into stock funds, it's overwhelmingly into passive index vehicles.

Year to date, $178 billion has gone into index funds, with $52 billion exiting actively managed portfolios that seek to beat an index. Since the end of 2008, there have been net redemptions from domestic equity funds, with the $756 billion into exchange-traded funds not quite offsetting the $877 billion out of traditional mutual funds. And over the past decade, Merrill says, $2.2 trillion has entered passive funds while the same amount fled active.

It's tough to pull a clear investor-sentiment signal from the sheer dominance of index funds. On the one hand, low-cost passive investments are simply a better mousetrap in many respects, one that's finally reached mass adoption.

Some argue that investors' willingness simply to accept the broad market's return shows a lack of the greed and hubris that often accompanies market peaks. Yet indexing also tends to be embraced in the latter stages of bull markets, as the public figures the asset class itself will give them plenty without paying a manager to try and outsmart it.

It's worth noting that whatever investors say and however they direct their marginal dollar, the public is plenty exposed to stocks right now, thanks mostly to market appreciation. Ned Davis Research tracks the percentage of household financial assets in equities, using Federal Reserve data. At last look it was 38.5 percent — well above the 28 percent long-term average and higher than at any time aside from the late-'90s bubble.

Seeing market metrics that are "highest ever aside from the Tech Bubble" has become commonplace. Broad equity valuations fit that description. The trailing price/earnings ratio on the median stock is now 23.8, likewise the highest outside of the years 1997-2000.

The 'most hated rally' in history

BAML equity strategist Savita Subramanian last week set out a thoughtful mock conversation between bulls and bears, detailing each group's prevailing arguments about valuation, growth, financial risk and the age of the economic cycle.

Her bottom line: We're overdue for a 5 percent-plus pullback, but with few signs of a bear market visible she sees stocks slightly higher by year-end: "Our work continues to suggest upside risk to stocks, driven by the simple fact that we have yet to witness euphoria on stocks."

Euphoria, presumably, defined in late-'90s terms.

Ever since Barry Ritholtz of Ritholtz Wealth Management called the then-six-month-old upswing "The Most Hated Rally in Wall Street History" in October 2009, observers have noted the skepticism surrounding this market cycle.

To many investors traumatized by two 50-percent market drops in the past 17 years, this bull market has been easy to denigrate — as conjured by central banks, goosed by cheap debt and share buybacks or unrepresentative of a slow-growth economy producing miserly wage gains and social unrest.

Yet it's worth asking whether all bull markets must last long enough for the man and woman on the street to get giddy.

Nearly a decade ago, I wrote a Barron's cover story about the conspicuous absence of the euphoric little guy in that bull market. The arguments paralleled those of Subramanian: Sure stocks weren't cheap and the pros were all in, but can we have a market top without small investors fully involved?

The article quoted a seasoned strategist thus: "One reason we remain cyclically positive on the broad market is that retail investors still have not participated. Instead, the public remains infatuated with global equities and corporate bonds. It is doubtful that the equity market would cyclically peak before the retail-investor enthusiasm for stocks had reached a more fevered pitch."

The article was published July 23, 2007. The S&P 500, it turned out, had only about 2 percent more upside over the next two-and-a-half months before the bear market, Great Recession and global financial crisis struck.

Yes, there were many extreme extenuating circumstances then: The public's greed, over-investment and excess borrowing had been going on outside of stocks in houses, and the credit markets were already under heavy stress at the time.

Today, credit is steady, corporate earnings are rising, economic excesses are largely in check and every little wobble in the market — such as last week's one-day dip — brings out overheated doomsday talk. The S&P 500 is up only 12 percent the past two years, and in the broad market half of all stocks are down 10 percent or more from the high — a discriminating, selective market pushing slowly higher for now.

Still, that 2007 example should give pause to anyone who thinks that all markets are safe from harm unless and until Main Street starts fully trusting Wall Street again.