Stocks are Doing Well ... Investors Remain Wary

Share prices are up ~10% for this year so far, but most individual investors continue to shy away from them.

Unfortunately, that's pretty much par for the course. We tend to buy high and sell low, always a bad idea and one which is very harmful to our economic health.

Stocks Continue to Defy Investors' Sour Mood summarizes the situation nicely:

"Amid a fresh barrage of bad economic news, the mood among investors these days is glum. So it might come as a surprise that stocks are actually up so far this year.

Stocks had swooned during the spring amid yet another flare-up of worries about Europe, with the Dow Jones Industrial Average losing 820 points in May alone.

But since then, the Dow has rebounded almost 700 points. Crucial to the bounce has been expectations that the Federal Reserve will move quickly should the U.S. economy deteriorate further.

As a result, even after a couple of white-knuckle days last week, the Standard & Poor's 500-stock index is up 10% so far this year.

The Dow has struggled a bit more, gaining 7% so far in 2012, but the technology-heavy Nasdaq is up a hefty 14%.

While that's good news for many portfolios, investors shouldn't get complacent. There are considerable risks both in the U.S. and abroad that could quickly send the still-jittery markets into a tailspin.

Not That Bad

Investors, particularly individual investors, haven't been convinced by the 2012 rally. They've bailed out of U.S.-stock mutual funds in droves—withdrawing $71 billion so far this year, according to the Investment Company Institute, the mutual-fund industry's trade group.

Bullish investor sentiment, as measured by the widely followed American Association of Individual Investors survey, was at its lowest in two years in the week ended July 19, before rebounding somewhat last week. Bearishness, meanwhile, is near recent peaks.

"There's this unbelievable disconnect between what the stock market is actually doing and the psychology of investors," says Liz Ann Sonders, chief investment strategist at Charles Schwab.

Ms. Sonders says that providing some support for stocks is a sense that although the U.S. economy is struggling, it's not falling into another recession. She points to economic data showing that while companies aren't adding significant numbers of new workers, they are increasing the hours worked by existing employees and hiring temporary staff. . . .

"Things aren't fabulous, but they aren't recession-like," says Ms. Sonders. The Schwab strategist expects a "muddle-through environment" for the U.S. economy and says that while stocks will likely continue to see sharp price swings, "it should be a pretty decent year."

Fed Is Ready

Another reason for hope that the U.S. can avoid recession is a belief that the Federal Reserve will move quickly to shore up confidence should the economy deteriorate further. . . .

Another prop for stock prices has been that by historical comparisons, prices aren't expensive, analysts say. For example, the price/earnings ratio for the stocks in the S&P 500, based on the next 12 months of expected earnings, is below 13, according to Thomson Reuters. That compares to a long-term average of around 15.

Those valuations have helped cushion worries that a softening of global economic growth is threatening to halt a remarkable run of earnings growth. "I don't need great earnings for stocks to be OK at these valuations," says Robert Doll, senior adviser at money-management firm BlackRock. "We would be having a different conversation if stocks were selling at 17 times earnings."

Stocks also have gotten a bit of a lift from a perception that, compared with other destinations for investors' money around the world, U.S. corporations provide some level of comfort thanks, in part, to huge piles of cash on their balance sheets.

"There's a semi-safe-haven status for U.S. stocks," says Mr. Doll. "Investors aren't going to buy emerging markets because those economies are slowing, they're definitely not going to buy Europe, but the U.S. is most likely going to be OK."

The Europe Effect

Still there are significant challenges for stocks, starting with U.S. politics.

The November presidential election and uncertainty about year-end expiration of tax cuts and economic stimulus aren't only keeping investors wary, but may be playing a role in the slowing of the economy as businesses defer hiring and spending plans.

Others worry that analyst forecasts for 2013 earnings are too high, which would mean stock valuations based on those estimates aren't reliable. . . .

Then there is Europe. In recent weeks, concerns have been building about the ability of Spain to pay its debts. Given the size of the country's economy and the limited resources of European bailout facilities, worries have resurfaced about the ability of government officials to manage the crisis.

Last week, nerves were soothed as the head of the European Central Bank suggested it would take whatever steps needed to hold the euro zone together. But analysts say Europe's fate will continue to play a key role in determining whether stocks can hold on to their gains.

"If Europe is quiet and not on the front page," says Mr. Doll, "the market will creep higher.""

My Take

Stocks will perform well over the long run.

They may very well continue to appreciate during the short term, too.

But then again, the may not.

That's why I believe it's a foolish game to try to time the market or guess the short term direction of stock prices.

And this is especially true when short term political activity is peaking, as is the case today, both in the U.S. and Europe as well.

In the meantime, it's been a nice ~10% or so ride so far this year, and we have ample reason to remain hopeful that the rest of the year and beyond may show solid share price appreciation as well.

As always, long term I'm very optimistic and intend to stay in the game of owning a diversified group of solid earnings growing, cash generating, dividend increasing, well managed and competitively well positioned blue chip companies.

Thanks. Bob.