Looking towards 2012, many investors are worried about their assets. Europe is in disarray, the U.S.debt is continuing to balloon, unemployment levels remain high, and no real concrete steps have been taken by political leaders to stem the negative sentiment. With all of this pessimism, in my opinion, this is a great buying opportunity for the long-term investor to acquire solid companies.
Generally speaking, you want to buy when people are selling, and sell when people are buying. The ICI, Investment Company Institute, tracks the flow of money into mutual funds. With December numbers in, the ICI reports that investors have been pulling money out of domestic mutual funds in every month since May; a total of $132 billion. That is a huge amount of money to be pulled out of the market, a sign of negative market sentiment. But, historically, when so many people have sold their stocks, it has provided a great buying opportunity.
Let’s take a look at recent history and see what has happened. We see a massive amount of money being pulled out of domestic mutual funds between September 2008 and March of 2009; again, poor market sentiment. The bottom of the market was March 2009. By looking at this one indicator of market sentiment, you can’t pick the exact top or bottom, of course. It is merely a tool to show you where the mass crowd of investors is moving their funds, but it gives you an idea that we’re closer to the bottom of the market. For someone with a long time horizon who averages into their trades, the aforementioned period in 2008-2009 represented an outstanding buying opportunity in stocks.
Let’s take a quick look at how U.S.corporations are performing. They are extremely strong, generating good profits and huge amounts of cash. By most accounts, corporations have three times the cash level they did 10 years ago. The dividend yield on the entire market, the S&P 500, at 2.47% is far above the 10-year U.S. Treasury yield of 1.9%. You are getting paid to invest in 500 of the largest corporations in the U.S. that are growing and flush with cash compared to the yield on a piece of paper from the U.S. government, which has astronomical levels of debt. This is shortsighted thinking from scared investors with negative market sentiment, which provides smart investors another buying opportunity.
A report by Barron’s showed the difference in yield between the earnings of S&P 500 companies, 8.6%, and the yield on 10-year U.S. Treasuries, 1.9%. This difference is the widest level—6.7%—than at any period since 1975! That was also a great buying opportunity in stocks!
For most of the last three decades, this spread has been zero. This indicates that people are scared, reflecting in negative market sentiment, selling their stocks and parking their cash in U.S. Treasuries. That will not last forever. When the shift occurs the other way, you will see the cash start moving back into stocks and pushing prices back up to “normal” valuation levels.
One area an investor should assess is their risk tolerance and time horizon. The indicators using money flow are very long-term in nature. From the beginning of money being pulled out of the market in the fall 2008, we saw the top in the S&P 500 occurring in the spring of this year, a period of just over two years. In the short run, there will be many fluctuations. Currently we’ve seen a large number of advisors become more bullish as the market moved up off the lows this year in October. In the short run, this may indicate that the market has gone a bit too far too fast. Patience is a virtue when investing for the long run.
Make no mistake about it; there are a lot of potential problems over the next decade. No one can know for sure what will happen. If we use history as our guide and someone were to buy when everyone else was scared and selling, there is a significant buying opportunity at those moments of extreme negative market sentiment.