Does Investor Gloom Mean It's Time to Buy?


Adages about going against the grain and buying when blood is in the streets get plenty of lip service. But like many things, buying at the point of maximum pessimism is easier said than done for most investors.

For those truly willing to bet against the crowd, though, now may be as a good a time as any to buy stocks. Individual investors, who have a storied history of getting the market exactly wrong, have suddenly become as bearish on stocks as they were in the wake of the credit crisis.

But the sudden burst of pessimism seems out of line with broader economic developments that continue to be mixed, meaning that risky assets like stocks may be undervalued because investors are being overly conservative.

On Pace for Record Corporate Profits

The proportion of smaller investors with a bullish outlook on the stock market over the next six months tumbled to 21%, from 30% just the week prior, according to a recent survey by the American Association of Individual Investors.

That marks the lowest levels since when the credit crisis began easing in March, 2009 -- just 19% of retail investors had a bullish outlook then. Stocks posted a monster rally in the months following March, 2009, and the sentiment could hardly have been more misplaced.

And the current economic situation is undeniably far better now than it was during the last bout of such pessimism, which followed a synchronized global collapse that pummeled the world economy.

A tepid U.S. economic recovery that hardly dented unemployment is already showing troubling signs of weakening. But companies are on pace to earn record profits in the coming year, according to analyst estimates, in stark contrast to the record losses they faced during the credit crisis.

Growth Elsewhere May Boost the U.S.

Much of that growth can be chalked up to once-again roaring emerging markets in Asia and Latin America. Europe, meanwhile, was left for dead just months ago much as the U.S. economy is today.

But the Continent has posted a sharp bounce back that has silenced most skeptics. And in an increasingly interconnected world economy, positive developments elsewhere have a good chancing of buoying the U.S. as well.

Some markets, though, are behaving much as they were when the world economy was in the midst of a historic decline. Yields on conservative assets like U.S. Treasury bonds, for example, have been pushed to levels not seen since the credit crisis. Some hysterical analysts, meanwhile, are predicting that yields will approach the record lows seen around the Great Depression.

Stock Yields vs. Bond Yields

The mismatch between an uneven but stable global economy and massive amounts of investor pessimism can best be summed up in the relative expected real yields of stocks vs. government bonds.

In the U.S., stock yields -- a measure of expected earnings compared to share prices -- is at a staggering 8% while government bonds are yielding merely 1% when modest inflation expectations are taken into account, according to JP Morgan.

Individual investors' gloom is easy enough to understand. Job growth has been painfully absent even a year after the recession ended, according to most economists.

But much like in March, 2009, when pessimism was supreme, investors may be throwing in the towel on stocks at among the worst possible moments.