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Ordinary Americans are losing faith in stocks

Investors » If pullback continues, implications for the economy, living standards are could be big.



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Many on Wall Street think this is an unnatural state that cannot last. After all, people tend to buy stocks because they expect them to rise in price, not because of the dividend. But for much of the history of U.S. stock trading, stocks were considered too risky to be regarded as little more than vehicles for generating dividends. In every year from 1871 through 1958, stocks yielded more in dividends than U.S. bonds did in interest, according to data from Yale economist Robert Shiller — exactly what is happening now.

So maybe that’s normal, and the past five decades were the aberration.

At a glance

Investment facts

Since 2007, individual investors have pulled at least $380 billion from U.S. stock funds.

Individuals have put more than $1 trillion into bond mutual funds alone since April 2007.

Foreigners, big purchasers in recent years, have sold $16 billion in the 12 months through September.

Public pension funds have cut stocks from 71 percent of their holdings before the recession to 66 percent last year.

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People who think the market will snap back to normal are underestimating how much the Great Recession scared investors, says Ulrike Malmendier, an economist who has studied the effect of the Great Depression on attitudes toward stocks.

She says people are ignoring something called the "experience effect," or the tendency to place great weight on what you most recently went through in deciding how much financial risk to take, even if it runs counter to logic. Extrapolating from her research on "Depression Babies," the title of a 2010 paper she co-wrote, she says many young investors won’t fully embrace stocks again for another two decades.

"The Great Recession will have a lasting impact beyond what a standard economic model would predict," says Malmendier, who teaches at the University of California, Berkeley.

She could be wrong, of course. But it’s a measure of the psychological blow from the Great Recession that, more than three years since it ended, big institutions, not just amateur investors, are still trimming stocks.

Public pension funds have cut stocks from 71 percent of their holdings before the recession to 66 percent last year, breaking at least 40 years of generally rising stock allocations, according to State and Local Pensions: What Now?, a book by economist Alicia Munnell. They’re shifting money into bonds.

Private pension funds, like those run by big companies, have cut stocks more: from 70 percent of holdings to just under 50 percent, back to the 1995 level.

"People aren’t looking to swing for the fences anymore," says Gary Goldstein, an executive recruiter on Wall Street, referring to the bankers and traders he helps get jobs. "They’re getting less greedy."

The lack of greed is remarkable given how much official U.S. policy is designed to stoke it.


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When Federal Reserve Chairman Ben Bernanke launched the first of three bond-buying programs four years ago, he said one aim was to drive Treasury yields so low that frustrated investors would feel they had no choice but to take a risk on stocks. Their buying would push stock prices up, and everyone would be wealthier and spend more. That would help revive the economy.

Sure enough, yields on Treasurys and many other bonds have recently hit record lows, in many cases below the inflation rate. And stock prices have risen. Yet Americans are pulling out of stocks, so deep is their mistrust of them, and perhaps of the Fed itself.

"Fed policy is trying to suck people into risky assets when they shouldn’t be there," says Michael Harrington, 58, a former investment fund manager who says he is largely out of stocks. "When this policy fails, as it will, baby boomers will pay the cost in their 401(k)s."

Ordinary Americans are souring on stocks even though stock prices appear attractive relative to earnings. But history shows they can get more attractive yet.

Stocks in the S&P 500 are trading at 14 times what companies earned per share in the past 12 months. Since 1990, they have rarely traded below that level — that is, cheaper, according to S&P Dow Jones Indices. But that period is unusual. Looking back seven decades to the start of World War II, there were long stretches during which stocks traded below that.

To estimate how much investors have sold so far, the AP considered both money flowing out of mutual funds, which are nearly all held by individual investors, and money flowing into low-fee exchange-traded funds, or ETFs, which bundle securities together to mimic the performance of a market index. ETFs have attracted money from hedge funds and other institutional investors as well as from individuals.

At the request of the AP, Strategic Insight, a consulting firm, used data from investment firms overseeing ETFs to estimate how much individuals have invested in them. Based on its calculations, individuals accounted for 40 percent to 50 percent of money going to U.S. stock ETFs in recent years.

If you assume 50 percent, individual investors have put $194 billion into U.S. stock ETFs since April 2007. But they’ve also pulled out much more from mutual funds — $580 billion. The difference is $386 billion, the amount individuals have pulled out of stock funds in all.

If you include the sale of stocks by individuals from brokerage accounts, which is not included in the fund data, the outflow could be much higher. Data from the Federal Reserve, which includes selling from brokerage accounts, suggests individual investors have sold $700 billion or more in the past 5½ years. But the Fed figure may overstate the amount sold because it doesn’t fully count certain stock transactions.

The good news is that a chastened stock market doesn’t necessarily mean a flat stock market.

Bill Gross, the co-head of bond investment firm Pimco, has probably done more than anyone to popularize the notion that stocks will prove disappointing in the coming years. But he says what is dying is not stocks, but the "cult" of stocks. In a recent letter to investors, he suggested stocks might return 4 percent or so each year, about half the long-term level but still ahead of inflation.

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