While you were sleeping, the financial market's health stabilized
The financial markets never fail to surprise most everyone, including the experts. While pundits pontificate, markets move in surprising ways, confounding seemingly insurmountable problems and reversing long- and short-term trends.
Last year was a very solid year for the market, but it was not as fruitful for many individual investors or market prognosticators.
For an amazing fifth year in a row, Americans sold stocks in 2012. This is the first time since such recordkeeping began during World War II that investors have been net sellers of the market during a sustained bull run, according to a detailed study that the Associated Press conducted.
The AP estimates that individual investors have pulled $580 billion from equity mutual funds and added $194 billion to equity exchange traded funds since April 2007, for a net withdrawal of $386 billion from stock funds.
Furthermore, the Federal Reserve compiles another data set about individual investors, including sales from brokerage accounts, and estimates that people have liquidated about $700 billion in net stock holdings over the last five-and-a-half years. Finally, again going back to April 2007, the Federal Reserve projects that institutional investors — pension funds, investment brokerages and governments — have liquidated $861 billion from equities.
Very often the media will portray the above statistics in a negative light and conclude that the cult of equities is over or that people will forgo stock investing for a generation. But counterintuitively, this disinterest in stocks helped lead to a healthy 2012.
In our view, with most of the "fickle" money out of the market, there are fewer investors left to panic sell than there were in 2007 and 2008. So the market appears to be building a base on strong earnings, higher dividend payments and corporate stock buybacks.
In other words, the fundamentals are strong and getting stronger while individual investors sit on the sidelines.
Not only have many individual investors gotten it wrong, but the professionals have, too.
Here is a short list of what the conventional wisdom was for 2012: emphasize dividend paying stocks above all others; the presidential election brings too much uncertainty, so shun equities; buy alternative investments to manage volatility; avoid Europe at all costs; and the bottom will fall out of this unstable market at any time.
In a year where the S&P 500 delivered stout double-digit returns, the 50 stocks in the index with the highest dividends returned about 0 percent. Just as remarkable, the 50 stocks in the S&P with the highest price-to-earnings ratios (the most expensive stocks) nearly doubled the return of the underlying market. The conventional wisdom to seek relatively "safe" stocks could not have been more inaccurate.
Many investors avoided the market because of the uncertainty of the presidential election year, even though history did not support this strategy. The year, of course, was not without its occasional hiccups.
Over April and May, the S&P 500 stock index fell by nearly 10 percent, and it again stammered in October and November, dropping more than 7 percent. But, remarkably, it never closed below its Dec. 31, 2011, level. Dating all the way back to 1928, this has happened only eight other times. This is evidence that the prognostications for a volatile market in 2012 did not materialize.
If you look at the Chicago Board Options Exchange Market Volatility Index, commonly referred to as the VIX, you can further see that market volatility has been relatively muted (the higher the reading, the more market volatility). Amazingly, even with the "fiscal cliff" debacle in Washington, the VIX approached only 20. It has dropped precipitously since then, to 13.5, whereas during the debt ceiling debate in 2011, the VIX was two-and-a-half times this level. The VIX hit 80, six times its current level, during the financial crisis.
The lack of real volatility also manifested itself in the performance of hedge funds — private investment pools designed to thrive in any market. Many investment advisers have their portfolios bursting with alternative investments, claiming that clients are presently more concerned with managing volatility than earning robust returns. The old adage of "watch what you wish for" held true as the Bloomberg Global Aggregate Hedge Fund Index gained a paltry 1.1 percent last year.
Many also believed that the euro would fail in 2012 and that the European Union and its stock markets would implode. As it turned out, Europe staged an impressive rally from its depths. Both the French and German stock markets topped the S&P 500 in 2012.
Finally, many still have not bought into the present bull market. Not only are folks skeptical, but more than a few have even refused to acknowledge its existence.
Our current bull market, which began in March 2009, has lasted nearly 1,300 days with the market rallying more than 100 percent. Since its establishment in 1928, this is the ninth longest bull market in the S&P 500's history. Waiting for "certainty" can most definitely be costly.
Ironically, while people have been having nightmares about the market, it has stabilized and charged higher. Until investors wake up to equities again, we believe the market will continue to surpass expectations, albeit with the inevitable speed bumps along the way.
Ben Atwater and Matt Malick are partners at Atwater Malick LLC, a registered investment adviser, which has offices in Lancaster and Dauphin counties. Email them at firstname.lastname@example.org and email@example.com.