Has the stock market finally entered a comfort zone?
Consider that the Standard & Poor's 500 index on Friday closed above 1,500 points for the first time since December 2007. Fourth-quarter earnings are mostly coming in strong. Less than four weeks into the year, stocks already are up 5 percent.
Anxiety has eased so much that the Chicago Board of Options Exchange Volatility Index, also known as the VIX, has dropped to its lowest level in nearly six years. Referred to as the market's fear gauge, it reflects expected movement in the S&P 500 over the next 30 days, as measured by options prices.
What's more, investors are finally returning to the market. U.S. stock mutual funds attracted nearly $13 billion in net deposits during the first two weeks of the year. That's an about-face from 2012, when withdrawals exceeded deposits for 24 weeks in a row, ending in late December.
A key reason that investors are back is the Jan. 1 deal between Congress and the White House to avert the so-called "fiscal cliff." Thorny issues remain unresolved, including spending cuts and potential reforms to entitlement programs like Social Security and Medicare. But there's no longer an immediate threat of fiscal disaster.
When stocks are rallying as they are now, investors should exercise caution. The market is up more than 120 percent since early 2009, and the strongest returns may be behind us.
Yet Bruce Herring of Fidelity Investments is confident that the long-term outlook remains bright. As a chief investment officer with Boston-based Fidelity, Herring helps oversee more than $500 billion in stock assets.
Herring explained his belief that stocks offer strong growth potential because investors face far fewer economic and political uncertainties than they did a few years ago. Below are excerpts from an interview, edited for clarity:
Q: What's the key reason that you're optimistic?
A: We're starting to achieve a level of clarity we haven't had in a long time, and that's really powerful for stocks. For starters, there's less uncertainty in Washington. In President Obama's first term, there were many crises and several industries came under increasing scrutiny and regulation. With so much uncertainty, companies behaved conservatively. They stopped hiring, cut capital spending plans and they didn't raise dividends.
With the election behind, we know we'll continue to have Democrats and Republicans each controlling one chamber of Congress, and a president entering his second term. We'll still have partisanship. But we're starting to get clarity around policies on financial services, energy and other areas. And we've got clarity about tax policy. We haven't had that in years.
Q: What makes you optimistic about the economy?
A: We're seeing a recovery in the housing market, and that matters to everybody, from corporate CEOs to consumers. A rising housing market is a powerful backdrop to general economic activity and the stock market broadly. Confidence matters a ton. Stocks are rallying this year because the market is operating on a longer time horizon, now that there's more clarity.
Q: But unemployment remains high, and there are other troubling signs in the economy.
A: Yes, but it's better when you look at what drives the stock market, and that's corporate earnings. Stocks continue to be priced inexpensively relative to the earnings they generate and we're seeing decent earnings growth. And America's competitiveness is very strong. Natural gas is incredibly cheap, and we've got an efficient and strong labor force. We've had lots of productivity improvements in corporate America and modest wage growth.
Q: How will uncertainty about fiscal issues in Washington affect the markets in the next few months?
A: There's incredible partisanship, which is obviously dysfunctional. When we had the debt ceiling debate and resulting credit downgrade in the summer of 2011, stocks fell about 20 percent in short order. But there was no comparable decline leading up to the recent fiscal cliff deal. Washington has found a new way to negotiate and the markets seem to be getting used to it.
In coming months, I suspect we'll have more last-minute compromises that won't make Republicans or Democrats happy, but will advance the ball a little bit. It doesn't matter much for corporate America, and for the market and average consumers. The economy and the strength of corporate profitability is what really matters.
Q: What do the stock market fundamentals tell you now?
A: Long-term, the case for stocks is great. We've got a low starting point for the market, after we've gone through a period of about 13 years where the market has generated no real returns based on stock price changes. Stocks have generated only a modest return if you factor in dividends. About a dozen years ago, stocks were trading at an average of about 26 times their expected earnings. Now, they're trading at about half that level, or 13 times expected earnings, so stocks are relatively inexpensive. Earnings have roughly doubled over the last decade, but the market has basically been flat.
Q: How do you explain the huge sums withdrawn from stock funds the past few years, and the huge amounts that have gone into bonds?
A: It's not surprising after what we've been through over the past dozen years. We've had the Sept. 11, 2001 terrorist attacks, wars in Iraq and Afghanistan, oil hitting $100 a barrel, a housing market meltdown and a financial crisis. There's been a lot of volatility in the stock market and people have been burned. The problem is that people tend to sell at the wrong time and lock in their losses, which makes it even worse.
Q: Can those investors get it right in the coming years?
A: Maybe not. My biggest worry is that 2008 was such a damaging experience to the psyche of America, especially for investors who were potentially less sophisticated and for those close to retirement. Their behavior has been influenced for a long time and possibly permanently. So I'm a little worried that as the market keeps rallying and investors perceive the market as less risky, the people who got out four to five years ago will think it's OK to get back in. I hope that people will come back to stocks, so that they're a consistent part of their portfolios over time. They're an asset class that's shockingly out of favor, despite good returns.
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