AAII Investor Update: Coping with the Uncertainty

Thursday, October 06, 2011
Charles Rotblut, CFA
AAII Journal Editor

AAII Resources

New Rules for Converting to a Roth IRA
Recharacterizing a Roth IRA may be worth considering in the current market environment.

AAII Discussion Boards
Do you know a 20- or 30-year-old who is investing in or avoiding stocks?

Most Popular AAII Articles

  1. “A Cautionary Note About Robert Shiller’s CAPE”
  2. “Preferred Stocks: An Overlooked Alternative”
  3. “The Role of Inflation-Indexed Annuities”
The S&P 500 temporarily fell into bear market territory this week, meaning it fell 20% from its 2011 highs. It’s a milestone that gets attention, but whether stocks are in a bear market or a severe correction isn’t that meaningful. Rather, what really matters is the dollar amount displayed on your brokerage statement.

2011 wasn’t supposed to be like this. The third year of a presidential term has historically been a good year for stocks. The Dow Jones industrial average has posted a positive return during every presidential third year since 1939. As of today’s close, the Dow has lost 3.9% year-to-date. We’re down, but with roughly 85 days left, there is still time for the 72-year winning streak to survive until at least 2015.

I realize that for many of you, the big question is not “Where will the markets end the year at?” but rather “How much downside is left in the markets?” According to Sam Stovall at Standard & Poor’s, the median post-WWII bear market decline for the S&P 500 is 28%. If we exclude the 51% median plunge of the three +40% mega meltdowns that have occurred since 1946, the median bear market drop is 26%.

No one really knows how big of a hole the current storm will create, because of the lack of clarity. Headlines out of Greece seem to change almost daily, and it continues to be impossible to predict when a resolution will be found. (Understand that the problem is not only sovereign debt, but worries that a default could cause a loss of confidence in several European banks.) On our side of the Atlantic, the economy is expanding, but at pace that could potential cause it to eventually stall. The risks of a recession have increased, but it’s not a certainty that we will see actual economic contraction. (And, yes, I realize that for many Americans, it feels like the 2008 recession never ended.)

There are reasons to be hopeful, however. A preservation plan for European banks could reassure investors that a default by Greece or another EU country would not create a widespread financial crisis. A bipartisan, long-term debt deal by the congressional super committee and the passage of some type of jobs plan by both houses of Congress could help here in the U.S. Decent third-quarter results (consensus earnings estimates call for S&P 500 profits to have risen 12.9%, according to Thomson Reuters) and favorable earnings guidance from corporations would be another positive development.

The eventual short-term outcome cannot be predicted by looking at fundamental data or charts. Many stocks are trading at low valuations (as of the end of last week, 187 S&P 500 stocks had a price-earnings ratio below 10 and a price-to-book ratio below 2), but they could get cheaper. Charts are showing a bearish pattern, but price patterns are merely sentiment indicators and daily market sentiment is being influenced by rumors.

If you can’t predict the outcome, you’re left with two options. The first is to sit out, wait for signs of certainty and then jump back in. This requires a high level of market timing accuracy, something most investors lack. It can also cause you to lock in big losses and miss out on big gains by getting out of the market too late and waiting too long to get back in. The second option is to focus on the long term, look for bargains and adjust your stock and bond holdings if they move too far away from your allocation targets. Granted, this disciplined approach may be easier said than done, but given the alternative, it is more likely to build long-term wealth.

Do you know a 20- or 30-year-old who is investing in or avoiding stocks? The reason I ask is that I continue to see stories about members of Generation Y who are avoiding stocks, even though their long investment horizons favor holding equities. Tell me on the AAII Discussion Boards.

Roth IRA Deadline on October 17

If you converted a traditional IRA to a Roth IRA in 2010 and want to recharacterize it back to a traditional IRA, you have until October 17 to do so. This January 2010 AAII Journal article explains why you may want to convert to a Roth IRA or undo a conversion from a Roth IRA and go back to a traditional IRA.

Steve Jobs

The world lost a talented innovator yesterday with the passing of Steve Jobs. My first computer was a Macintosh Plus and I’ve had a favorable attitude toward Apple (AAPL) ever since. Looking back, that 1980s Apple computer enabled me to gain skills that have been beneficial throughout my career.

Steve Jobs exerted strong will at Apple, with a sharp focus on even seemingly minute details. Though Apple has many talented employees and will probably have continued success, the intangible value that Jobs added will be very hard to replace. In an era when many CEOs are grossly overpaid, Jobs created lasting wealth for his company’s shareholders.

The Week Ahead

The U.S. bond markets and government offices will be closed on Monday in observance of Columbus Day, but the U.S. stock exchanges will operate on normal hours.

Third-quarter earnings season “officially” starts on Tuesday afternoon when Alcoa (AA) reports. Joining Alcoa will be fellow Dow component JPMorgan Chase (JPM) and fellow S&P 500 member Google (GOOG), which both report on Thursday. In total, we’ll see earnings reports from nearly 10 S&P 500 member companies.

Most of the economic data will be published on Friday, when we will see September retail sales, the preliminary October University of Michigan consumer confidence survey, September import and export prices and August business inventories. The minutes from last month’s Federal Open Market Committee meeting will be released on Tuesday afternoon. Otherwise, the only data releases scheduled are the weekly reports like initial jobless claims (published on Thursday mornings).

Philadelphia Federal Reserve Bank President Charles Plosser and Cleveland Federal Reserve Bank President Sandra Pianalto will speak publicly on Wednesday. Minneapolis Federal Reserve Bank President Narayana Kocherlakota will speak on Thursday.

The Treasury Department will auction $32 billion of three-year notes on Tuesday, $21 billion of 10-year notes on Wednesday and $13 billion of 30-year notes on Thursday.

AAII Sentiment Survey

Sentiment Survey

This week’s AAII Sentiment Survey results:
  Bullish: 35.2%, up 2.7 points
  Neutral: 19.0%, down 1.6 points
  Bearish: 45.7%, down 1.1 points

Long-term averages:
  Bullish: 39%
  Neutral: 31%
  Bearish: 30%

Take the AAII Sentiment Survey »

Bullish sentiment rebounded to a five-week high in the latest AAII Sentiment Survey. Optimism that stock prices will rise over the next six months rose 2.7 percentage points to 35.2%. Even with the improvement, bullish sentiment remained below its historical average of 39% for the 11th consecutive week.

Neutral sentiment, expectations that stock prices will stay essentially flat, fell 1.6 percentage points to 19.0%. This is the lowest level of neutral sentiment since November 11, 2010.

Bearish sentiment, expectations that stock prices will fall over the next six months, declined 1.1 percentage points to 45.7%. This was the eighth time in the past 10 weeks that bearish sentiment has been above 40%. It is also the 30th time out of the last 33 weeks that bearish sentiment has been above its historical average of 30%.

Individual investors continue to fret about the direction of stock prices. Concerns about the pace of economic growth, worries about European sovereign debt, frustration with Washington and volatile market conditions are combining to keep bearish sentiment at historically high levels.

This week’s special question asked AAII members where they foresee the U.S. economy headed over the next six months. The majority of respondents thought the economy would expand, albeit at a slow pace. A minority are expecting the U.S. to fall into a double-dip recession, while a few believe the pace of economic expansion will accelerate.

Here is a sampling of the responses:

  • “I expect continued slow growth until the fiscal uncertainties are clarified.”
  • “I suspect no growth on average, with minor ups and downs while the Congressional deadlock continues.”
  • “Slow growth that could morph into a double-dip recession if the European situation is not resolved.”
  • “I think we will have continued slow growth while Washington dithers.”
  • “Definitely slow to no growth, with a double-dip recession coming.”

Are you bullish, bearish or neutral? Take the AAII Sentiment Survey and tell us.

AAII Asset Allocation Survey

September Asset Allocation Survey results:
Stocks/Stock Funds:
 57.8%, up 2.5 points
Bonds/Bond Funds:
19.3%, down 2.3 points
 22.8%, down 0.3 points

Asset Allocation details:
  28.3%, up 1.1 points
Stock Funds:
  29.6%, up 1.5 points
  4.1%, down 1.6 points
Bond Funds:
  15.2%, down 0.7 points

See the survey »

Individual investors shifted portfolio assets back into stocks and stock funds, while keeping their exposure to equities below average for the second consecutive month. The September AAII Asset Allocation Survey found that individual investors held 57.8% of their portfolios in stocks and stock funds. This was a 2.5% increase from the prior month. Even with the increase, however, the allocation was below the historical average of 60%.

Bond and bond fund holdings declined to 19.3%, a 2.3% drop. Nonetheless, the current reading is consistent with the fixed-income allocations recorded by the survey throughout 2011. Furthermore, the allocation to bonds and bond funds remained above the historical average of 15% for the 28th consecutive month.

Cash allocations declined by 0.3% to 22.8%. September was the third time in four months that cash allocations were above 21%. The historical average is 25%.

Individual investors continue to struggle with a lack of attractive choices for short-term total return. Enthusiasm for Treasury bonds is tempered by historically low yields. Sentiment toward stocks has been negative, as the S&P 500 tumbled 14.3% last quarter. As a result, cash allocations are staying at their highest levels since the summer of 2010.

Last month’s special question asked AAII members what impact the Federal Open Market Committee’s decision to keep interest rates unchanged until at least 2013 has had on their sentiment toward bonds. A large number of individual investors expressed pessimism about the outlook for bonds, and many said they were either avoiding bonds altogether or reducing their exposure. A smaller number described themselves as optimistic about bonds, noting that the Fed’s August announcement provided clarity. Some AAII members are favoring either short-term, corporate, high-yield or international bonds. A few expressed a preference for dividend-paying stocks.

Here is a sampling of the responses.

  • “I am negative about U.S. government bonds; the yield is practically nothing.”
  • “I am retired and rely on interest from bonds as part of my income. I hate the low rates. It is impossible to get moderate income at moderate risk.”
  • “I will be forced into more equities in a quest for better total return. A tough choice for one who is already retired.”
  • “(The Fed’s announcement) helped big-time to keep interest rates low and make investing in bonds a little safer.”
  • “I am looking at alternatives, including preferred stocks, variable annuities, intermediate corporate bonds and international bonds.”
  • “I am refinancing my home loan to lock in the lower rates.”

Take the survey:

Wishing you prosperity,

Charles Rotblut, CFA
AAII Journal Editor