Investor Optimism Soared Just Before Markets Tumbled

Stock Market

Federal Reserve Chairman Ben Bernanke indicated Wednesday that the central bank may phase out stimulus, a move that sent U.S. stocks into the red for two consecutive days and the Standard & Poor’s 500 Index down more than 5 percent from a record high. But before the Federal Open Market Committee stirred up investors’ fears, the stock market had traced out a seemingly-endless rally, prompting some investors to question whether the equity markets could possibly go any higher in the near-term, while the great majority expressed notably high optimism about the investment climate.

Since the U.S. equity market’s low in March 2009, there has been a great deal of growth; large capitalization stocks have gained about 150 percent while mid- and small-cap stocks are up about 200 percent; price-to-earnings ratios have been trending down and current S&P 500 earnings are approximately $105, a significantly higher return than experienced in the previous stock market peaks in 2000 and 2007.

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Simultaneously, investor optimism has soared. The Wells Fargo/Gallup Investor and Retirement Optimism Index increased to a reading of 43 in May, up from 31 in March and minus 8 last November. Prior to the recent downturn, investors were about as optimistic about the investment climate as they have been at any time in the past several years. The index came close to this level early in 2011, but the last time the index hit 43 was before the Great Recession. It peaked at 178 in January 2000, just before the dot-com bubble burst, and hit a low of minus 64 in 2009, just before the equity markets bottomed out.

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The index, which based on a random sampling of 1,426 investors, is conducted quarterly. The most recent reading was taken between May 16 and May 27.

At that time, 54 percent of polled investors said that it was a good time to put money in the financial markets, up from 51 percent in March and 39 percent in November 2012. Still, 62 percent of investors anticipated that a market correction would take back significant market gains later this year. Despite that stipulation, only 16 percent of those who expected a correction said they shifted into safer investments. Eighty percent made no changes to their portfolio’s composition.

However, the federal government’s inability to agree on measures to lower the deficit and put the budget on a more financially sound foundation may keep optimism from rising further. Investors that participated in the survey were asked which of 10 specific issues presented the greatest challenge to the investment climate. Seventy-three percent said that the “politically divided federal government” is hurting the current investment climate “a lot,” an issue that has been at or near the top of investors’ concerns since September 2001. The federal budget deficit was listed as the second-greatest concern, garnering 67 percent of votes, and unemployment came in third, with 55 percent of respondents saying it is hurting the investment environment a lot.

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Investors’ concerns about the politically divided government were mirrored Gallup’s recent poll regarding the current problems facing the country, and congressional gridlock was the main reason four and five Americans said in June that they disapproved of the job Congress is doing. Increasing optimism is also consistent with Gallup’s measure of economic confidence that reached a new monthly high in May. The rising stock market and increasing home prices appeared to have improved confidence last month to a level not recorded since before the recession and financial crisis.

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But, as Gallup noted, it is also not surprising that the markets began to tumble not long after many average investors started to feel optimistic about them. “Average investors often seem to be the last to jump on the bandwagon on the way up, and tend to be last to get off as the markets correct,” noted the study. “That is, by the time there is a general consensus that the markets are improving, they are often peaking. And, by the time the need to get out of the markets is obvious, many savvy investors have already left.”

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