The Market Thoroughly Convinces Investors to be Optimistic

By on December 26, 2010

Paul J. Lim, senior editor at Money Magazine, has written an article published in The N. Y. Times revealing that investors made decent returns by taking on more risk in the past decade:

Risk-taking hasn’t been rewarded over just the last 18 months. Despite all the talk about what a “lost decade” this has been for investors, risky asset classes have actually produced sizable gains over the last 10 years. For instance, though the average fund that invests in large-capitalization domestic stocks gained just 1.5 percent, annualized, in that period, small-stock funds returned nearly 7 percent a year. And emerging-market stock funds returned nearly 15 percent, annualized, during that stretch, according to Morningstar.

Risk-taking was also well rewarded in the fixed-income markets. While safe government bond funds gained 4.8 percent, on average, for the past decade, slightly riskier investment-grade corporate bond funds gained 5.4 percent, annualized, and high-yield bond funds — even riskier — returned nearly 7 percent a year.

Lim goes on to point out that the easy money has likely been made and investor optimism may be unwarranted:

INDEED, some market strategists worry that investor optimism itself may be a headwind to another strong year for the market. Consider how stocks performed in other recent periods of optimism. In October 2007, a survey by the American Association of Individual Investors found that 55 percent of investors were bullish; in the 12 months that followed, the S.& P. 500 fell 37 percent. Similarly, in March 2000, investor bullishness reached 66 percent. And a year after the fact, stocks were down 25 percent.

It just goes to show that by the time the market thoroughly convinces investors to be optimistic, most of the good news is already behind us.

SMA Comment: The market’s strength despite downright humdrum economic news is encouraging for the coming year. It is surprising, given all the problems we have now (i.e., exploding deficits, municipalities on the brink, housing in the dumper), that investors are exhibiting such high levels of bullish sentiment. It appears the biggest factor influencing sentiment is simply the market moving to higher ground. I’m expecting some short-term disappointment (cratering stock prices) to bring investors back to reality.  However, once this price correction of perhaps 4-7% is completed, sending sentiment to more reasonable readings, stocks will probably make their way to higher ground.

Source: The N. Y. Times
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