Dangerous Denial


Talk to your average market bear, and his or her story likely goes something like this: Investors are in denial. They're not paying attention to the risks. They're complacent and oblivious to looming threats.

Maybe that's true. But look at the results of a recent survey by Franklin Templeton investments, and it looks like just the opposite is occurring.

Franklin surveyed 1,000 investors, asking whether they thought the S&P 500 (INDEX: ^GSPC) had gone up or down in each of the last three years.

The results are incredible.

In each year, an average of 56% of respondents said the market declined. But it didn't. The S&P rose 26.5% in 2009, 15.1% in 2010, and 2.1% last year.

Cumulatively, stocks returned 70% from the start of 2009 through this morning -- one of the best three-year runs in history. And yet the majority of investors seem to have their heads firmly in the sand, refusing to believe it. "La la la la -- I can't hear anything!"

This is dangerous denial. There's little evidence of investors fleeing stocks lately, but we know they've been plowing money into bonds, where they're virtually promising themselves negative future returns. You can only assume that people are flooding the bond market because they've felt burned by the stock market. But the irony is painful: The stock market has been an absolute gold mine in recent years.

It's actually not surprising that so many are unaware of the market's rise. Most of the economic numbers over the past three years have been miserable. Unemployment is high. Wages are dropping. Measures of poverty have surged. The government deficit runs more than a trillion dollars per year. If you focus on these ugly economic stats alone -- and they dominate the headlines -- you can't be blamed for thinking the market must be dropping. How could it not during such havoc?

The answer is simple, really. There's very little direct correlation between today's economy and today's stock prices. The market looks ahead. It doesn't care about today's economic numbers. It doesn't even care about tomorrow's economic numbers. It cares about businesses' ability to generate future cash flow. And there's just no way around it: Businesses have done a magnificent job keeping profits intact, even while the economy slows. Corporate profits were at a new all-time high before unemployment had even peaked. There's a big disconnect between middle-class America and corporate America's profitability. And for better or worse, markets are driven by the latter.

"[No] one likes to admit this but the last three years have been great for buy-and-hold," analyst Eddie Elfenbein wrote earlier this year. You just had to stick with it. Stocks go up, and stocks go down. If you let yourself get washed out during bear markets, you'll invariably miss the ensuing rise. And that rise always happens before the economy gets better. Or, as Warren Buffett put it in 2008, "If you wait for the robins, spring will be over."

The largest gains are behind us, but I don't think it's too late for hope. The S&P trades at around 15 times earnings -- not cheap, but not outrageous. Berkshire Hathaway (NYS: BRK.B) still trades at a price-to-book ratio well below its historical average and only 10% above valuations Buffett himself was bullish on. Other blue chips like Johnson & Johnson (NYS: JNJ) offer historically stable dividends that yield double what's offered in Treasuries.

Stocks will almost certainly outperform bonds in the long run. You just have to give them a shot -- and keep your mind open to reality.

The article Dangerous Denial originally appeared on Fool.com.

Fool contributor Morgan Housel owns shares of Berkshire and Johnson & Johnson. Follow him on Twitter @TMFHousel.The Motley Fool owns shares of Berkshire Hathaway and Johnson & Johnson. Motley Fool newsletter services have recommended buying shares of Berkshire Hathaway and Johnson & Johnson. Motley Fool newsletter services have recommended creating a diagonal call position in Johnson & Johnson. The Motley Fool has a disclosure policy.We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. Try any of our Foolish newsletter services free for 30 days.

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