Paul J. Lim, senior editorOctober 21, 2010: 5:34 AM ET(Money Magazine) -- On paper, this seems like a hospitable environment for the bulls on Wall Street to roam. The recession that began in late 2007 has officially been declared over. Interest rates and inflation are at historic lows, and stocks are up more than 70% from their low 18 months ago.
But when you flip on CNBC or turn to your paper's business section, it's all gloom and anxiety. The talking heads are warning that the economy could be headed for a double-dip recession or maybe something worse.
Meanwhile, mutual fund managers are sitting on cash, and a recent survey of investment newsletters found that bearish advisers vastly outnumbered bulls for the first time since the market cratered in March 2009.
Individual investors have caught the pessimism bug too: At the end of August, only 21% of individual investors described themselves as being bullish, vs. about 50% who said they were bearish.
That spread between optimists and pessimists hasn't been so wide since the credit crisis nearly two years ago. Since the start of 2009, $70 billion has been yanked out of U.S. stock mutual funds while more than half a trillion dollars has gone into bonds.
"Sometimes it feels like I'm the last optimist standing," says University of Pennsylvania professor Jeremy Siegel, whose book Stocks for the Long Run was the bible of '90s bulls.
Now a puzzle: If investors are feeling so crabby, why aren't stocks cratering? It could be that they're caught up in the market's mixed signals. It's unclear right now whether you can consider the broad market cheap or dear.
So while there's no obvious rationale to sell just now, it might just take a little bit of bad news -- such as a surprisingly bad earnings report -- to send investors running. But there's also a strong counterargument that the dearth of bulls is a good sign. Four reasons not to listen too closely to the bears:
Right now there's an overhang of fear in the market that's not justified by companies' fundamentals. People's anxiety about their own jobs and the economy is probably spilling over into their portfolios.
And David Kotok, chief investment officer of Cumberland Advisors, says investors are still gripped by "financial post-traumatic stress disorder" left over from the 2008 crisis.
But as a group, investors' emotional weathervanes very often point the wrong way.
For example, at the end of the bear market in March 2009 the pessimists outnumbered the optimists by nearly 2 to 1. Yet in the 12 months that followed, the Standard & Poor's 500 index soared more than 60%.
Similarly, in October 2002 the number of bearish investors greatly outnumbered the bulls just as the stock market was about to enter a five-year rally. And on the flip side, asks Siegel, "How many bears could you find in tech stocks in March 2000?" Not many, but that was just before the Internet bubble burst.
How to play it: This adds up to a case for sticking by your stock allocation. But recognize that fragile investor sentiment could lead to a short-run market drop. That would be a timely occasion to book some profits in bonds and recommit that money to stocks.
"If you focus solely on the economy, you could get bearish," says Ronald Muhlenkamp, manager of the Muhlenkamp Fund. "But when you look at the health of companies themselves, it's very easy to get bullish."
For one thing, after getting out from under debt over the past two years, corporations are now sitting on more than $1 trillion in cash.
Ironically, a big reason investors are so worried about the economy is that corporations are doing too good a job sticking to their financial diets. As companies both big and small have gotten rid of debt at a record pace, they've simultaneously cut back cold turkey on spending and investing, which is one reason cash reserves are soaring.
The good news is that some of this cash is starting to come off the sidelines and is being deployed in ways that could benefit you.
For instance, as merger-and-acquisition activity has begun to pick up recently, stock prices have also begun to rise. In addition, companies in the S&P 500 have boosted their dividend payments by nearly $14 billion so far this year, after slashing their payouts by $37 billion in 2009. Dividend-paying stocks have returned more than 10% this year, three times the return of the broad market.
How to play it: First, take a look at tech stocks. The sector, which used to shun dividends, now accounts for nearly 10% of the S&P's payouts, as industry titans like Intel (INTC, Fortune 500) are kicking back more cash to their shareholders.
In May, Intel said the company would double its earnings over the next five years. Even if the company can't achieve this through simple growth, it has enough cash to buy back stock and double per-share profits. "Meanwhile, you're getting paid a 3.3% yield to wait," says Robert Turner of Turner Investment Partners.
If you'd rather invest in tech via a fund, Technology Select Sector SPDR (XLK) is an exchange-traded fund with a focus on larger companies. For a more diversified play on dividends, consider Vanguard Dividend Growth (VDIGX). Unlike many dividend funds, it doesn't just buy stocks with the highest yields, but includes newly emerging -- and faster-growing -- dividend payers.
At least the global economy isn't. Take Europe, for example. While southern European countries were walloped by a debt crisis earlier this year, the region appears to have addressed many of those concerns.
In September, the European Commission nearly doubled its forecast for the region's growth this year, from 0.9% to 1.7%. Beyond Europe, the global economy is expected to grow at least 3.5% a year through 2014, which is about a third faster than projections for the U.S.
How to play it: Think European-based multinationals. Though European stocks are rebounding, they're still cheap. Historically they've traded at a 15% premium to the S&P; today they're even.
Kotok likes Siemens, which is based in Germany, one of the region's strongest economies. The giant diversified manufacturer is growing 15% a year but trades at a P/E of less than 12. If you prefer funds, Vanguard Europe Pacific ETF is a MONEY 70 choice with two-thirds of its stake in Europe.
While there's great debate whether the broad stock market can be viewed as cheap, it's still easy to find attractively priced stocks right now. Bill Miller of Legg Mason Capital Management, a famous bull from the 1990s, argued in a recent commentary that some of the biggest high-quality U.S. firms are as cheap as they've been since 1951.
How to play it: Following a maverick like Miller is risky. His main fund lost big in 2008 as he stuck by financial stocks. But he also has a record of spotting huge opportunities others have missed, and his case for Exxon Mobil (XOM, Fortune 500) is intriguing. He notes it's cheaper now than it was during the financial panic. �
