Sonders on “Rational Exuberance”

Retail investors have, at long last, been coming back to stocks in the first month or so of 2013, and Charles Schwab Chief Investment Strategist Liz Ann Sonders says it’s a rational move for them.

In her latest market commentary, Sonders looks at how negative sentiment and mutual fund flows have gone over the past few years. She even cites one Franklin Templeton survey showing that the majority of investors weren’t even aware that the market had risen in 2009, 2010, in 2011. She says that while the recent influx of money into stock funds has been significant, it represents only a fraction of the money removed from stock funds by retail investors over the past few years. Short-term sentiment indicators are showing some warning signs, she says, but for the longer-term she says “there are few major warning signs”.

Sonders discusses a couple key factors that are giving stocks a tailwind right now. “Although I do spend a lot of time researching and writing about how the economy affects the stock market (and vice versa), I’ve also learned that the monetary and liquidity cycles are most important to the stock market in the shorter term,” she writes. “‘Don’t fight the Fed’ was a phrase coined by famed investor Marty Zweig — my boss from 1986-1999. It’s no less true today. He used to pair that phrase with ‘don’t fight the tape,’ and clearly that’s been in play these past few years, too. Periods of monetary expansion combined with low inflation have generally been heady juice for stocks.”

Sonders also references another investment guru — hedge fund manager Ray Dalio — in discussing the high amount of cash sitting on the sidelines. At the recent World Economic Forum in Davos, Dalio, she says, explained that “the returns on cash are terrible. So as a result of that, what we have is a lot of money in a place — and it needed to go there to make up for the contraction in credit — but a lot of money that is getting a very bad return. That, in this particular year, in my opinion, will shift. And the complexion of the world will change as that money goes from cash into other things.”