| Podcast - Client Portfolio Manager Kevin Collins on Investor Sentiment |  |
Alger Client Portfolio Manager Kevin Collins discusses the current bullish investor sentiment environment and addresses some of the concerns investors may have.
Kevin Collins: Good afternoon. This is Kevin Collins. At Alger, we believe current investor sentiment readings are very bullish and some of you may have concerns about this.
The American Association of Individual Investors Sentiment Survey on 11/6/13 indicated a bullish posture to the degree of which had not been seen since 2007. Additionally, Investors Intelligence Bull/Bear Ratio recently hit 3.5X more bulls than bears. That was of 11/7/13. This occurs very infrequently. These strong bullish indicators have led some investors to ask: Is everybody already in the market? Is it too late to participate? Should I get out now? Today, I’m going to share some of our research with you and try to clarify a few of these issues.
First, I will describe to you some research that argues against those questions. I will talk about the funds flow that’s been experienced in bonds and equities as well as the recent returns and current valuations. And finally, we’ll look at research that discusses the practicality of shifting from bonds to equities and from dividend equities to growth stocks in the current economy. Let’s begin.
I described to you very bullish sentiment readings from the American Association of Individual Investors as well as the Investors Intelligence Bull/Bear Ratio. According to the research firm Renaissance Macro Research, we looked at the bull/bear ratios’ history as of November 7, and saw that 3.5x bulls over bears was a finding that occurs very infrequently. In fact, it’s only happened on 17 occasions since 1963. What then can we expect in the wake of those readings? What does the market do? Renaissance Macro Research found that 1‐year out returns from those starting points tended to be above average, a very positive finding. In fact, since 1970 Renaissance Macro found that investors actually realized a median 11.25% return in the 12 months subsequent to a 3.5x bull-to-bear reading versus a typical 12 month return for the S&P500 of only 9.4%. Further, according to Renaissance Macro, the market was more likely to be up after those very positive sentiment readings than under typical market conditions.
This empirical analysis appears to show that bullish investor sentiment should not deter investors who are eager to initiate or maintain greater exposure to equities.
Let’s talk a little bit about the recent market experience as it relates to funds flow. According to Morningstar, at the end of September, money flows, cumulatively, since the end of 2008 had flown to bonds to the tune of $1.2 trillion while equities have experienced a net outflow of $122B. In each and every year since the end of 2008 bond inflows have been positive. Even year-to-date, funds flow has been a positive $56B to bond funds. In each and every year - 2009, 2010, 2011, and 2012 - money flowed from equities. It’s only been in 2013 year-to-date that money has started to flow back to equities. So, it’s still very early in the beginning of this trend. To recap, a very substantial $1.2 trillion into bonds, a flow that’s continuing, while $122B left equities and has only begun to return 2013 year-to-date.
Another thing to consider – despite these flows, equities posted a relatively strong return compared to bonds. Let’s take a look at those returns. The 10-Year Treasuries annualized return from 12/31/08 through the end of October 2013 was up 2.5%. The U.S. Aggregate Bond Market was up 4.8%. And municipal bonds – as measured by the Merrill Lynch Muni Master Index – were up 6.6% during this period. The best individual sector for bond returns – those of the U.S. High Yield market – was up 19%. That was the only area of the bond world that exceeded stock market returns in the wake of the 2008 crisis, and in fact only exceeded the S&P500, which was up 17.3% during this period. Growth stocks, as represented by the Russell 1000 Growth Index, did even better at 19.8%. So, despite those very negative flows away from equities and towards bonds, stocks outperformed bonds. And growth stocks did better than the S&P500 Index.
Let’s take a look at where the asset classes currently stand. The S&P500 Free Cash Flow yield, according to Factset, is positive and above the current 10-Year Treasury yield of 2.75% as recorded on November 8th. It’s also important to note, despite the relatively strong outperformance by U.S. equities relative to the fixed income market, that 3/5ths of the constituents in the S&P500 Index actually have higher free cash flow yields than the 10-Year Treasury’s yield according to Factset as of 10/31/13.
Let’s take a look at current equity stock valuations. According to Empirical Research Partners, for year-to-date through September 30, 2013, large cap stocks’ nominal free cash flow yields are comparatively higher than historic levels, meaning that stocks are not extended on a valuation basis. And the price to cash flow of the broader market, as measured by the S&P500 Index, looks almost at the very middle of the 20-year range. So despite relatively poor funds flow and strong equity returns, the relative attractiveness of equities to bonds appears to be squarely in the middle of its long-term historical range.
So, some investors might observe that equities seem to present a better value than bonds, especially as U.S. equity values don’t seem to be particularly extended from historic levels.
This discussion comes into greater focus in the context of Ben Bernanke’s recent tapering message on May 22. From May 22 through Sept 18, the 10-year Treasury was down 2.2%; the U.S. Aggregate Bond Index was down 2.4%; the U.S. High Yield Index was down 1.7%. Merrill Lynch’s Muni Master Index got hit even harder – it was down 5.3%. Stocks, however, were notably positive. The S&P500 was up 4.1%, and the Russell 1000 Growth Index was up 5.3%. So you see, in that tapering period when markets were concerned that the Fed would remove its quantitative easing stimulus, bonds underperformed and equities outperformed. The returns were even more positive among growth stocks.
So, a market observer could argue that there’s a significant potential on a forward basis for Investors to shift from bonds to equities as well as a shift from income-generating stocks to growth stocks.
At Alger, we share the optimism for equities. Given our proprietary, fundamental, bottom-up research, we remain enthusiastic about segments of our economy that are benefitting from positive dynamic change. These areas include ecommerce, mobile connectivity, cloud computing, a persisting recovery in residential housing activity, as well as an energy renaissance. And these sectors are well-represented in Alger portfolios.
Thank you.
The views expressed are the views of Fred Alger Management, Inc. These views are subject to change at any time and should not be interpreted as a guarantee of the future performance of the markets, any security or any funds managed by Fred Alger Management, Inc. These views should not be considered a recommendation to purchase or sell securities. Individual securities or industries/sectors mentioned, if any, should be considered in the context of an overall portfolio and therefore reference to them should not be construed as a recommendation or offer to purchase or sell securities.
Investing in the stock market involves gains and losses and may not be suitable for all investors. Growth stocks tend to be more volatile than other stocks as the price of growth stocks tends to be higher in relation to their companies´ earnings and may be more sensitive to market, political and economic developments.
Founded in 1964, Fred Alger Management provides investment advisory services to institutional and individual investors through traditional and alternative strategies in a variety of products, including separate accounts, mutual funds and privately offered investment vehicles. For more information, please visit www.alger.com.
