Many sit out a strong stock rally; small investors wary of losses if they take the plunge

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Call it the Rodney Dangerfield rally. Like the economic recovery that underpins it, the bull market on Wall Street today gets no respect.

The stock market recently surged to five-year highs and appears headed within a few weeks to all-time highs for the Dow Jones industrial average, the Standard & Poor’s 500 and other major indexes.

Yet many professionals on Wall Street, businesses on Main Street as well as investors seem unconvinced that the rally is on solid ground. Many small investors also have sat out the rally, unwilling to enter a market that they fear will shift into reverse and wipe out their gains.

The deep skepticism can be seen in the market’s tentative and halting movements as it approached new highs in recent weeks. The Dow soared over 14,000 one day on modestly positive economic news only to shrink below that milestone the next day as doubts cropped up about the expansion, political tensions in Washington or the possibility of further weakness overseas. The Dow ended the day Thursday down 10 points at 13,973 — just shy of the 14,000 mark it pierced barely two weeks earlier.

Rarely has the market’s advance of more than 125 percent since hitting bottom nearly four years ago been accompanied by a more robust debate about why it is occurring.

For skeptics, the market seems to be on a sugar high caused by too-loose money policies at the Federal Reserve, which they say has stoked artificially low interest rates and enabled the U.S. government to keep piling up unsustainably high debts. They think the combined stock and Treasury bond bubble will burst and investors will rue the day they put their trust in the market. Many of these skeptics are heavily invested in stock alternatives such as gold, which they say will weather the coming reckoning in stocks.

“Rising stock prices have not convinced many Americans to get into the game,” said John Browne, senior economic consultant at Euro Pacific Capital, a contrarian investment firm that touts gold as the best value in today’s shaky economy. “While the Dow has in fact surged in nominal terms, the leading U.S. equity funds continue to show significant outflows of investment funds,” reflecting the public’s doubts about the foundations for the market’s rise, he said.

Bulls see good signs

But bullish stock gurus are unapologetic in trumpeting the market’s virtues. They point out that the environment for stocks has rarely been so favorable. Labor costs — the biggest expense for most businesses — have never been so low nearly four years into an economic recovery. That has enabled corporations to plump up their profits, pile up record amounts of cash, focus on strategies for expanding business in promising areas overseas, and cut costs ruthlessly when necessary to maintain excellent financial health and impress investors.

Market bulls also point out that stock valuations at about 15 times earnings on average remain historically low, suggesting the market still has room to grow. They also applaud the record low rates and lenient policies at the Fed, which they say have enabled corporations to easily refinance and issue debt, for considerable cost savings in recent years, while making stocks far preferable to the negligible returns investors receive on bonds and money market funds. They say the Fed’s easy money policies are clearly justified in light of the economy’s sluggish growth and stubbornly high unemployment rate.

Stock market bulls point out that federal deficit spending, while a danger in the long run, has benefited investors and many corporations for years by driving profits in defense and health care, among other industries, while propping up demand in the economy and profits for the business sector at large.

Bulls also like the market’s slow and fitful recovery, saying it’s normal for stocks to have to climb a “wall of worry” before broaching new highs.

Scott L. Wren, senior equity strategist at Wells Fargo Advisors, expects stocks to move to new highs this year, with the S&P 500 working its way up to a record around 1,575.

“The market started off the year with a bang,” with the S&P 500 surging nearly 6 percent in January after notching an impressive 13.4 percent gain in 2012, despite signs that economic growth stalled at the end of last year amid the budget wars in Washington, he noted.

The secret to the market’s success? “Companies overall have figured out how to make money in this slow-growth environment where inflation has not been a problem and costs have been contained,” he said.

Influx of small investors

At this point, many investors who missed out on the early part of the rally are starting to join the market, adding fuel to the rally, Mr. Wren said.

“Baby boomers are sitting on too much cash and are concerned about the prospects of outliving their money,” he said. “With [bank certificates of deposit] yielding almost nothing, dividend-paying stocks are getting more attention.”

But Mr. Wren concedes that the Johnny-come-latelies to the market remain tentative. “In past cycles, investors would have been trying to jump on the rally train long before now. But this recovery has been different. The economy and labor market have only improved slowly,” he said, and investors are still nursing wounds from the hits they took in the financial crash of 2008.

Ross Koesterich, global chief investment strategist at Black Rock’s iShares, is neutral on the U.S. stock market this year, recommending that investors look for what he expects to be better growth and returns in emerging, market stocks. But he says investors are making a big mistake if they are sitting out the worldwide stock rally.

“The return on cash left in a bank account was negative for 2012. In comparison, world equity markets returned 13.4 percent in U.S. dollar terms during the same period,” he said. Studies show that “investors are roughly twice as sensitive to losses as they are to gains,” he said. Still, people need to get over their bad experiences during the two market crashes of the past decade and give stocks another chance, he said.

Craig Turner, an analyst at Daniel’s Trading, is also bullish about the stock market and said the influx of small investors has just begun.

“The biggest winner is the equity market so far, but I expect more and more money to move into a wide range of risky assets like commodities, real estate, venture capital and the like,” he said.

“There will be hiccups along the way. Europe always has the potential to cause a market sell-off,” he said. Indeed, news emerged Thursday of a deepening recession in Europe.

“The U.S. and Europe are by no means stellar growth prospects,” Mr. Turner said, “but they both seem to always be able to get past a crisis and keep on going. The U.S. dealt with the fiscal cliff [deadline on Jan. 1] and I’m sure they will deal with the debt ceiling, too,” he said, referring to Washington’s need to raise the national debt limit once again this spring.

“Even if the U.S. and Europe continue to kick the can down the road, the markets at this point don’t mind,” Mr. Turner said. “Kicking the can down the road is the new normal, and we can go on like this for a long time before having to pay the piper.”

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