Welcome to 2012! No doubt many investors are glad to leave 2011 behind, marked as it was by such volatile market swings and continued fear and uncertainty. Now that's not to say that investors won't face a fresh set of challenges in the new year, but there's nothing like a new page on the calendar to give us hope for the future.
Unfortunately, hope seems to be in rather short supply these days among the financial advisor set, at least when it comes to the outlook for stocks. According to InvestmentNews' 2012 Investment Outlook survey, advisors are much more bearish on equities than they were last year. But that doesn't necessarily portend doom for the stock market.
Contrarian indicators
The recent InvestmentNews survey indicates that only 43.6% of respondents are planning on increasing their clients' allocation to stocks in 2012, while another 42.7% said they will hold their current equity allocation steady from last year's level. Perhaps not surprisingly with all the drama surrounding the eurozone debt crisis, advisors are even more bearish on foreign prospects, with just 18.7% responding that they will increase client exposure to international stocks. These numbers stand in contrast to last year's findings, in which 63.4% of advisors said they would increase exposure to stocks in general and 60.2% were planning on upping their foreign stock allocation.
While most financial advisors are lovely people, they are prone to the same kind of rearview thinking and performance-chasing tendencies as the rest of us. Consider that almost two-thirds of advisors looked to increase their allocations to stocks at the start of last year, no doubt based in part on equity performance in 2010. But after the ballots were counted, the domestic stock market ended 2011 in approximately the same place it started, and foreign developed markets were down nearly 12%.
History has proven time and time again that when the mood of the investing public is bearish, that's generally a positive signal for the markets, and vice versa. After all, who wanted to buy stocks in the spring of 2009? Not many folks, but that's right about the time the market bottomed and went on to double its fortunes. So if retail investors and the financial advisor community alike are somewhat skittish about stocks for 2012, I think that's a good indication that there could be some hidden opportunities out there.
Going against the grain
More important, while stocks could certainly lose ground in 2012, it's unlikely that they will continue to lag bonds a whole lot longer. Over the very long term, stocks have always outperformed bonds. Ibbotson Associates data going back several decades tells us that from 1926 through 2010, large-cap stocks have returned an annualized 9.9% versus 5.5% for long-term government bonds. So it's not unreasonable to expect stocks to do better than bonds over the long run.
But wait a minute. Didn't we just see all those headlines a few months ago about how bonds had actually beaten stocks over the past 30 years? Well, that's true -- for the period from October 1981 through September 2011, long-term Treasury bonds gained 11.5% compared to 10.8% for the S&P 500 index.
That time period, however, included two huge bear markets for stocks (2000-2002 and 2007-2009) and a multi-decade bull run for bonds. If you look at most other rolling 30-year periods with different start and end dates, stocks still come out the winner. If you mess with enough beginning and ending points, including or excluding the right market environments, you're definitely going to get a few periods like this, where stocks lag. But even so, those periods are very rare.
Remember that old saw about reversion to the mean?: The longer an asset class outperforms (or underperforms), the more likely it is to revert back to its historical long-term average. And given that bonds have been posting above-average returns for the better part of two decades while stocks have been basically running in place over the past 15 years, I'd say it's a fair bet that stocks have more upside potential at this point in the market cycle than bonds do.
Living large
But while advisors in the InvestmentNews survey aren't terribly keen on stocks, I do think they've got the right idea as to where to look for the best opportunities this year. According to the survey, the corner of the market most favored by the advisor respondents is large-cap value funds. If we're talking about investing in financially healthy, dividend-paying stocks, I think there's a lot of wisdom in that viewpoint.
Given how low bond yields are, dividend-producing stocks offer a compelling alternative for investors in search of income and capital appreciation. Two of my favorite exchange-traded funds that invest in this market segment are Vanguard Dividend Appreciation ETF
Of course, I don't think investors should completely ditch large-cap growth funds in favor of income-producing large caps. I think the key to success in 2012 is to strike a solid balance between growth- and value-oriented large-cap names. To balance out the value side of your portfolio, consider inexpensive ETFs like Vanguard Growth ETF
Ultimately, you may not be tickled pink at the thought of owning stocks right now, but after market sentiment turns bullish, you'll have already missed out on some decent gains. So make sure you've got some skin in the stock market game, especially in the favorably valued large-cap blue chip sector.
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