Investors Fearful as Stock Rally Best Since 1987

By Nikolaj Gammeltoft, Inyoung Hwang and Whitney Kisling - Feb 6, 2012 7:07 PM GMT+0700

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Feb. 6 (Bloomberg) -- Dennis Stattman, a fund manager at BlackRock Inc., talks about the stock and bond markets and investment strategy. He speaks with Erik Schatzker on Bloomberg Television's "InsideTrack." (Source: Bloomberg)

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Feb. 6 (Bloomberg) -- Nicholas Colas, chief market strategist at ConvergEx Group, talks about investment strategy and the outlook for global markets. Colas, speaking with Deirdre Bolton and Dominic Chu on Bloomberg Television's "In the Loop," also discusses Europe's debt crisis. (Source: Bloomberg)

The Standard & Poor’s 500 Index’s best start in 25 years is doing little to restore Americans’ confidence in the stock market.

The benchmark gauge for U.S. shares has climbed 6.9 percent in 2012, the most since it rose 14 percent to begin 1987, data compiled by Bloomberg show. It traded at an average of 14.1 times earnings since the start of 2011, the lowest annual valuation since 1989. More than $469 billion has been pulled from U.S. equity mutual funds over five years and New York Stock Exchange volume slipped to the lowest since 1999.

Pessimism is taking a toll on the securities industry, where more than 200,000 jobs were lost last year, even as U.S. unemployment declines as the economy accelerates. Sentiment is the worst since the early 1980s, when 17 years of equity market stagnation gave way to the biggest rally in history.

“Investors are scared to death,” Philip Orlando, the New York-based chief equity strategist at Federated Investors Inc., which oversees about $370 billion, said in a telephone interview on Feb. 3. “The fears are justified, but from a valuation standpoint the market has overshot, as it typically does. We’ve been pounding the table to put money into equities.”

The Standard & Poor’s 500 Index rose 2.2 percent last week to 1,344.90 after U.S. unemployment fell to the lowest level since February 2009 and manufacturing grew at the fastest rate in seven months. S&P 500 March futures retreated 0.4 percent at 7:05 a.m. in New York today.

Companies whose shares dropped at least 20 percent last year helped lead the gain, with Whirlpool Corp. (WHR) climbing 26 percent, Genworth Financial Inc. (GNW) rallying 17 percent and Cummins Inc. increasing 13 percent.

Three-Year Rally

Sentiment has deteriorated even as the S&P 500 rose 99 percent since March 9, 2009. The 106 percent expansion in U.S. earnings during the last nine quarters, the most since 1987, helped fuel the rally. For the period ended Dec. 31, 67 percent of companies in the S&P 500 beat analyst profit estimates as earnings advanced 3.3 percent.

Investors pulled money from mutual funds that buy U.S. stocks for a fifth year in 2011, the longest streak in data going back to 1984, according to the Investment Company Institute in Washington. Withdrawals were $135 billion last year, the second-highest total after 2008, the ICI said.

Concern European leaders will fail to keep Greece from defaulting, the May 2010 flash crash in which $862 billion was erased from equities in less than 20 minutes and some of the most volatile markets on record last year helped spur the withdrawals. Of the more than $11.1 trillion that was wiped off U.S. shares between 2007 and 2009, $8.1 trillion has been restored.

‘Never Happened’

“The stock market has effectively doubled since the March ’09 low, and we’re still in redemption territory for equity funds,” Liz Ann Sonders, the New York-based chief investment strategist at Charles Schwab Corp., said in a Feb. 2 phone interview. Her firm has $1.7 trillion in client assets. “That’s never happened.”

Money managers haven’t kept up with the S&P 500’s advance. Hedge funds declined 5 percent in 2011, the third year of losses since 1990, according to Chicago-based Hedge Fund Research Inc. A total of 21 percent of 525 global fund categories tracked by Morningstar Inc. topped their benchmark indexes last year, the fewest since at least 1999.

‘Fear and Anxiety’

Valuations have fallen even as the S&P 500 rallied 21 percent since the end of 2009 because profits increased five times as fast. The price-earnings ratio for the benchmark gauge of American equities has fallen to 14 times reported income, down from 24 at the end of 2009. The ratio slipped as low as 10.2 at the end of the 17-month bear market in 2009, when the S&P 500 declined 57 percent.

“It was the severity and the quickness of the fall and how long it’s taking to come out of the trough that’s been adding fear and anxiety,” Warren Koontz, head of U.S. large-cap value stocks at Loomis Sayles & Co. in Boston, which manages about $160 billion, said in a telephone interview on Feb. 3. “Over time, if things continue to progress on a step-by-step basis, people will come back to stocks.”

Trading at the New York Stock Exchange declined to the lowest level since 1999 last month, with the average volume over the 50 days ending Jan. 25 slowing to 838.4 million shares, according to data compiled by Bloomberg. The value of stock changing hands dropped to $24.9 billion, a 50-day average not seen since at least 2005.

That’s contributing to a contraction on Wall Street. The number of securities professionals registered with the Financial Industry Regulatory Authority fell to 629,518 last year, the lowest end-of-year level since at least 2002.

Kaufman, WJB

At least three New York securities firms folded this year. Kaufman Bros. LP, with a staff of about 40, WJB Capital Group Inc., which had more than 100 employees, and Ticonderoga Securities LLC, with about 75, closed as trading slowed and funding evaporated.

“Institutional traders are more cautious, and the long- only investors like mutual funds, which are typically a source of demand, that money’s been coming out for the past four years,” Walter “Bucky” Hellwig, who helps manage $17 billion of assets at BB&T Wealth Management in Birmingham, Alabama, said in a Feb. 2 phone interview.

While Wall Street retreats, U.S. employers added 243,000 non-farm jobs in January, the most in nine months. Confidence among U.S. homebuilders rose in January to the highest level since 2007, according to an index released Jan. 18 by the National Association of Home Builders and Wells Fargo & Co.

Whirlpool Rally

Among the 20 stocks in the S&P 500 with the largest gains this year, seven were among the 20 worst in 2011. Genworth, the mortgage guarantor and life insurer, has rallied 40 percent after losing 50 percent in 2011 even as earnings increased 65 percent. Analysts project the Richmond, Virginia-based company will almost triple profit in 2012.

Whirlpool in Benton Harbor, Michigan, posted the second- best gain in the S&P 500 this year as its income for the final three months of 2011 beat analyst estimates by 26 percent -- better than 92 percent of the 264 companies in the index that have reported since Jan. 9. The world’s largest maker of household appliances slid 47 percent in 2011, plummeting after July on increased concerns about the economy stalling.

A 36 percent rally in Cummins (CMI) shares this year comes after the Columbus, Indiana-based maker of diesel engines lost 20 percent in 2011. While earnings beat estimates in all but the third quarter last year and no analyst recommends selling the stock, investors pushed its valuation to 9.9 times reported earnings. The price-earnings ratio surged 36 percent in 2012.

Lost Decade

Rallies have faded since 2000, when the dot-com bubble drove the Dow Jones Industrial Average (INDU) to a record high. The gauge peaked at 11,722.98 that year, and has risen above and then fallen below that level seven times since. It ended at 12,862.23 on Feb. 3, up 5.3 percent so far this year.

The past decade parallels the span between Dec. 31, 1964, and the end of 1981, when the Dow added less than 1 point after surging interest rates diminished the appeal of equities. While the 115-year-old stock gauge ended the period at 875, it ranged between 577.60 and 1,051.70.

After stalling for 17 years, the U.S. stock market staged the biggest bull market in history through early 2000, driving the Dow up 15-fold from its low point in 1982. The surge coincided with a decrease in the yield on 10-year Treasuries to 6.68 percent from 13.55 percent. The rate was 4.21 percent at the end of 1964, and it peaked at 15.84 percent in 1981. On Feb. 3, the figure was 1.92 percent.

Lower Rates

Falling interest rates failed to lift stocks in the last decade as the S&P 500 slumped 12 percent from its high in March 2000. Equities slipped as the global economy experienced two financial crises, including the worst recession since the 1930s. Growth in U.S. gross domestic product averaged 2 percent a year between 1999 and 2011, compared with 3.6 percent between 1964 and 1981, and 3.3 percent from 1981 and 1999, according to data compiled by Bloomberg.

The retreat leaves stocks in position to rally because so many bearish investors can be lured back to equities and the market is cheap, according to Scott Minerd, the chief investment officer of Santa Monica, California-based Guggenheim Partners LLC, which oversees more than $125 billion.

“Stocks are poised for a generational bull market, whether it starts this year, or next year, or in five years, is anybody’s call,” he said. “Even if we had a 50 percent increase in multiples, stocks would still be cheap.”

To contact the reporters on this story: Nikolaj Gammeltoft in New York at ngammeltoft@bloomberg.net; Inyoung Hwang in New York at ihwang7@bloomberg.net; Whitney Kisling in New York at wkisling@bloomberg.net

To contact the editor responsible for this story: Nick Baker at nbaker7@bloomberg.net