Contrarian Corner: Are We Finally Seeing the Necessary Aversion Toward Stocks?

At the tail end of a bear market, investors shun stocks. According to the Wall Street Journal, signs of this trend are increasing.

After investors were burned last decade in successive bubbles bursting, from 2007-2009 individual investors took out more money from the stock market than they put in. That’s the first three year decline since 1979-1981.

This year, U.S.-stock funds saw inflows in January, March and April, but net withdrawals resumed in May.” Given the market direction this summer, we can safely assume withdrawals continued since May.

On its face, this is a bad sign because individual investors fueled stocks to incredible new heights in the 1990s. However, from a psychological perspective, this is a necessary phase which will reset the markets for a future bull run. As every pro trader knows, these are all future buyers. The issue is not “if”, rather “when?”.

Confidence is falling everywhere. Last Friday the Thomson Reuters/University of Michigan Consumer Sentiment Index fell off a cliff. This morning the National Association of Home Builders Housing Market Index fell to a 15-month low. And investors are losing confidence too:

Investors talk of a growing disillusionment with big institutions, including corporations, government, banks and political parties—as well as fears about the nation’s heavy debt … and volatility.

These are all great reasons to either distrust or hate stocks. And in order for us to set the stage for another long term secular bull market, we need to get a load of prospective demand on the sidelines. As research firm Trim Tabs notes, “the market tends to rise after equity ETFs post heavy outflows.”

However, this healing process will not occur overnight. “Historically, it has taken an extended period of stock success to lure individuals back after long periods of disaffection.” This may dishearten the get-rich-quick crowd. But for those like us who are simply looking forward to setting the stage for prosperity at some point in the next decade, we look forward to investors shunning stocks in the near-term.

In the chart below “Psychology of a Market Cycle” we can see the classic phases of a market cycle. Based on the information you read and see, are we at the stage of disbelief? Are we still in the anger phase? Or, are we somewhere else entirely?

Let your opinion be heard in the comments below …

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