The Market’s Unsustainable Pace
Thursday, March 14, 2013
Charles Rotblut, CFA
AAII Journal Editor

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Sentiment Survey

This week’s AAII Sentiment Survey results:
  Bullish: 45.4%, up 14.4 points
  Neutral: 22.5%, down 7.9 points
  Bearish: 32.0%, down 6.5 points

Long-term averages:
  Bullish: 39.0%
  Neutral: 30.5%
  Bearish: 30.5%

Take the AAII Sentiment Survey »


Many headlines have focused on the Dow Jones industrial average’s record high and its 10-day winning streak. Less noticed is the S&P 500’s attempt at its own closing record. The large-cap index ended today just two points shy of its 1,565.15 closing high set on October 9, 2007.

It’s certainly feel-good news, but you would be wise to keep your joy in check. The S&P 500’s year-to-date total return (price appreciation and dividends received) was 9.5% as of yesterday (S&P Dow Jones indexes had yet to update the total return figures to encompass today's close at pixel time). This equates to an annualized gain of approximately 60%. I don’t have to rely on my cracked crystal ball to tell you this size of a gain will not happen. Since 1926, large-cap stocks have only realized full-year gains in excess of 50% two times (1933 and 1954) according to the Ibbotson SBBI 2012 Classic Yearbook (Morningstar, 2012).

Before you put on your bear cap and hunker down, be aware that stock prices do not have to endure a steep correction to correct their course. Rather, a couple of modestly down months and a few flat months could slow the pace of this year’s annualized return without causing much pain to your portfolio. It is very possible that 2013 could end up being a great year for stocks without the market indexes maintaining their current pace of gains.

Plus, just because stocks are rising at an above-average rate of return does not mean they have to fall by an amount large enough to bring the annualized rate of return back to its average. An often misunderstood part of statistics is that reversion to the mean allows for streaks of above average and below average readings. Large-cap stocks can realize returns well above and well below their 9.8% average for a period of time before reverting back toward their average performance. Reversion to the mean allows the markets to be irrational far longer than you can remain solvent.

Of course, none of this answers the question some of you probably have, “Should I buy or sell stocks right now?” Though the correct answer is to stick to your long-term allocation plan and to not worry about the market’s short-term movement, I realize that kind of thinking is not often easy to follow. So, here are three observations.

Relative valuations are getting expensive. As we observed in the March AAII Dividend Investing monthly report, which was published last Friday, nearly half of the 948 dividend-paying companies within the S&P Super Composite 1500 are trading with yields below their five-year averages. (Price and yield are inversely related, so low yields imply high valuations.) On a price-earnings basis, just 39% of the index members with five-year price-earnings (P/E) ratios trade at a discount to their historical five-year averages.

Conversely, the length of the current bull market, which is turning five years old, favors the bulls. In a report published this past Monday, Sam Stovall at S&P Capital IQ wrote, “Since WWII, the S&P 500 turned on the after-burners in year five, with the remaining bull markets averaging a 21% increase in price -- four of which were in double digits. In addition, four of the five bull markets went on to celebrate their sixth birthday.”

Then there is the macro environment. The market remains more focused on the positive news, such as the improving jobs data and rebounding housing market, than the negative news, such as North Korea’s saber rattling (and hopefully it’s just saber rattling). Sequestration, Europe, Japan and China are all factors that could adversely impact the U.S. economy. Favorable outcomes to some or all of these events would help stocks. The uncertainty is part of the randomness that characterizes stock prices over the long term.

If it were easy to decipher what the market will do next, everyone would successfully employ market timing techniques. The simple facts are that the market moves in ways we don’t expect and focusing on the short-term variations can prevent you from making progress on your long-term goals. So, enjoy the new highs, but realize what happens next week or next month is nowhere as nearly important to your portfolio as what happens over the next decade.

More on AAII.com

Since I realize opinions about where the market is headed next are mixed, this week I’m featuring one article for those of you who are optimistic and one article for those of you who are cautious.

The Week Ahead

I will be conducting a webcast presentation to our Florida West Coast Chapter on Tuesday, March 19. If you are in the St. Petersburg area, I invite you to attend. AAII’s Joe Lan will speak to our Chicago Chapter on Saturday, March 23. Visit the AAII Local Chapters page for information about all upcoming meetings, including ones near you.

Nine members of the S&P 500 will report earnings next week: Adobe Systems (ADBE) and Cintas Corp. (CTAS) on Tuesday; FedEx Corp. (FDX), General Mills (GIS), Jabil Circuit (JBL), Lennar Corp. (LEN) and Oracle Corp. (ORCL) on Wednesday; and Nike (NKE) and Ross Stores (ROST) on Thursday.

The Federal Open Market Committee will hold a two-day meeting starting on Tuesday. In addition to publishing the meeting statement, committee members will also release their updated forecasts on Wednesday afternoon. Federal Reserve Chairman Ben Bernanke will hold his quarterly press conference at 2:30 E.T. on Wednesday as well.

The economic calendar is otherwise light. February housing starts and building permits will be released on Tuesday. Thursday will feature February existing home sales and the March Philadelphia Federal Reserve Survey.

This Sunday is St. Patrick’s Day. Remember to wear something green.

Finally, the NCAA men’s basketball tournament starts on Tuesday with the four play-in games. Though I’ll be rooting for my Kansas Jayhawks to make the championship game for the second consecutive year, I fully realize this college basketball season has been unpredictable. Good luck filling out your brackets; we’ll all need it this year.

AAII Sentiment Survey

Bullish sentiment posted its largest weekly gain in nearly three years, as neutral sentiment plunged according to the latest AAII Sentiment survey.

Bullish sentiment, expectations that stock prices will rise over the next six months, surged 14.4 percentage points to 45.4%. The spike in optimism was the largest since an 18.4-point weekly gain on July 15, 2010. This week's jump puts optimism at a six-week high. The historical average is 39%.

Neutral sentiment, expectations that stock prices will stay essentially unchanged over the next six months, plunged 7.9 percentage points to 22.5%. Neutral sentiment is now at its lowest level since November 15, 2012. The historical average is 30.5%.

Bearish sentiment, expectations that stock prices will fall over the next six months, fell 6.5 percentage points to 32.0%. Even with the decline, pessimism is above its historical average of 30.5% for the fourth consecutive week.

Though this week’s spike in bullish sentiment is large, it primarily represents a reversion to the mean. Two weeks ago, just 28.4% of surveyed AAII members described themselves as optimistic, the lowest level since November 2010. Furthermore, while large spikes in bullish sentiment are unusual, they are not extraordinary. Over the past five years, bullish sentiment has jumped by double-digits 17 times.

The current level of bullish sentiment is not excessive, but it does in part reflect the Dow Jones industrial average’s nine-day winning streak. While the streak has prompted some investors to be more optimistic about the short-term direction of stock prices, many AAII members remain leery that stocks are overbought and due for a correction. Also impacting sentiment are mixed views about the pace of economic growth and ongoing frustration with Washington.

This week’s special question asked AAII members how the new record highs set by the Dow Jones industrial average has influenced their opinion about the attractiveness of stocks. Responses were mixed. The largest group of respondents (approximately 30%) said the new record highs had no impact. Approximately 18% of respondents expect stock prices to pull back in the short term, though some AAII members think the pullback will be followed by a rebound to even higher prices. Roughly 17% said they are now more cautious or bearish, while 11% said they are more bullish. A couple of respondents said it is harder to find bargains in the current environment.
Here is a sampling of the responses:

  • “The new highs concern me a little, as we may be getting ahead of ourselves.”
  • “I am reluctant to put new money (except for my regular contributions) into the market right now.”
  • “As stocks go up in price, they are more risky in my view, but I think stocks still have more upside than downside at current levels.”
  • “I have to search harder to find stocks of value.”
  • “The record high has not influenced my opinion.”

» Take the sentiment survey