Data shows that retail investors have not yet bought into the bull market. But when they eventually do regain their confidence, the market will soar to new heights.
Consider this: Trim Tabs Investment Research, a boutique data analysis firm in the San Francisco Bay area that's popular with hedge fund managers, last week declared that it had turned fully bullish from cautiously bullish on U.S. stocks. The firm thus boosted its recommended equity exposure to 100% long from 50% long.
The reason for Trim Tabs' change of posture: Its unique blend of macroeconomic data shows the U.S. economy making a gradual recovery, corporate buybacks are picking up during earnings season, and demand indicators are increasingly bullish.
Let's spend some time understanding their point of view, as the firm is influential among large institutions.
First, its analysts see income tax withholdings up 3.4% year-over-year in the past month, which is quite a bit higher than the 2.9% year-over-year growth rate seen in the three months prior. That suggests wages and salaries are rising sequentially, which is something we've talked a lot about in the past month. Also, Trim Tabs' proprietary measure of online job postings is up 33% year-over-year, which is the best reading of the past year.
As the economy improves, companies are feeling more confident about their business, and in many cases, they are investing in their own stock instead of just adding new production lines in their factories. When companies take stock out of circulation via buybacks, their earnings per share naturally rise. That makes their valuation lower, which in turn attracts more open-market purchases from third parties. Public companies also are buying other public companies at an increasingly rapid rate, which has the effect of taking more stock out of circulation.
Trim Tabs reports that five new cash takeovers using $3.9 billion in cash were announced in the past two weeks, and new stock buybacks last week rose to a four-week high of $4.5 billion. This is the ultimate in insider buying. Meanwhile, not too many initial public offerings are being launched, as the new-issues calendar has been relatively quiet.
Finally, Trim Tabs notes that investment demand trends are very favorable. They measure this in two ways, one conventional and one original. The first combines price, volume and breadth to determine the extent to which demand is exceeding supply; it's much like the method that Lowry's Research Corp. uses to construct its Buying Power and Selling Pressure indexes. The more interesting second approach determines the balance of fear and greed by looking at the cash balance of equity funds, excess margin debt, exchange-traded fund (ETF) flows and retail money market fund assets.
That second measure is super-bullish, says Trim Tabs, for this reason: Despite the continuing rally off the March 2009 and February 2010 lows, investors pulled $2 billion out of U.S. equity funds in April, bringing the year-to-date outflow to $6.6 billion. ETF investors tend to buy high and sell low, which Trim Tabs says that makes their actions one of the best contrary indicators in their data sets. In short, the more ETF investors hate stocks, the more Trim Tabs likes them.
Trim Tabs notes that U.S. equity funds have posted outflows in six of the past eight months, and have not received a $10 billion-plus inflow since May 2009. Since the average U.S. equity fund is up 8.6% this year, and the Standard & Poor's 500 Index is up 79% since the March low, it's pretty amazing that U.S. stocks aren't drawing more interest from mutual fund investors.
Strangely, the analysts observe that global funds remain much more popular than U.S. equity funds, taking in $4 billion in April. But it's bonds that are really getting the love. Bond mutual funds took in around $20.2 billion in April.
Trim Tabs says it's remarkable that retail investors don't seem to worry about governments' ability to service their debt, or that the average bond fund is up only 2% this year. In total, bond funds have received $110.6 billion this year, say the analysts - about 3.5 times the $32.0 billion that has flowed into equity funds.
Bottom line: The public has still not bought into this U.S. bull market yet. Retail investors will, you can be sure, but it will take a while before they are comfortable with the idea of even starting the task. Once they do, the inflows will likely swell over a period of years - much as occurred in the 1990s - not months. It is a little hard to remember back that far, but I vividly recall investors anticipating a 1987-style crash and double-dip recession from 1991-1994. They finally got a very slight recession in mid-'94, and it was only in 1995 that the meat of the 1990s bull market got underway. A similar scenario, with a different script, may be awaiting us in this decade.
The only caveat, and it's a big one, is that Europe and China are not cooperating with U.S. strength and could drag down Wall Street. We'll keep a close eye on this development to see whether this wrinkle develops into trouble.
[Editor's Note: As this market analysis demonstrates, Money Morning Contributing Writer Jon D. Markman has a unique view of both the world economy and the global financial markets. With uncertainty the watchword and volatility the norm in today's markets, low-risk/high-profit investments will be tougher than ever to find.
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