Will Good News Convince Main Street to Buy Stocks?

NEW YORK (AP) — The fear that kept small investors from participating in one of the greatest bull markets in history may be losing its grip.

The White House reached a tentative deal with Republican leaders last week to cut taxes. Economists are raising their estimates for economic growth, and jobless claims have fallen 15 percent from a year ago. The monthly trade report released Friday showed surging demand for American products, and the University of Michigan's December consumer sentiment index reached its highest point since June. There's even good news about two symbols of Wall Street recklessness. The government sold its last stock in Citigroup Inc. on Tuesday and could do the same soon with its stake in American International Group Inc.

The Standard & Poor's 500 index closed at 1,240 Friday, surpassing the level from before the financial meltdown in September 2008. And a survey by the American Association of Individual Investors showed the number of people bullish about stocks outnumbering those bearish by the widest margin in more than three years.

"There was this widespread expectation six months ago that we were going to have a double dip recession," says Steven Bleiberg, manager of the Legg Mason Lifestyle funds. "That whole mindset has petered out."

Arnold Espe, the bullish manager of USAA's Cornerstone Strategy Fund, predicts investors next year will put more money into U.S. stock mutual funds than they take out for the first time since 2006. Says Espe: "We're setting up for a pretty good market."

Trying to guess what individual investors will do next is difficult, and the optimists could be dead wrong. There are plenty of reasons investors might balk at buying U.S. stocks, not least an unemployment rate of 9.8 percent. But if Espe is right, the market could rise smartly. Optimism about stocks can feed on itself. If small investors put back into the market even a fraction of the tens of billions that they took out in the past year, it could set off a virtuous cycle of buying.

One sign that stocks may soon attract money: Though investors pulled $500 million more from U.S. stock mutual funds than they put in last month, the pace of withdrawals is slowing, according to fund tracker Strategic Insight. As recently as September, investors took out a net $15 billion.

Small investors could turn to stocks soon because the alternative — bonds — don't look so safe anymore. For most of the year, small investors have used the billions they've withdrawn from stocks to buy bonds. The thinking was that bonds were safer because the principal is guaranteed. It's been a good move. Though the S&P has risen 11 percent since the beginning of the year, some bonds have done better. So-called junk bonds from highly indebted U.S. companies have gained 16 percent and bonds from emerging markets, 14 percent, according to Barclays Capital.

But now doubts about bonds are creeping in.

Fear is rising that an improving economy will stoke inflation that could eat into bond returns. Inflation sends bond prices down sharply because the principal won't buy as much when returned if prices rise.

Treasury bonds maturing in 10 years lost 4.2 percent in the past month, and in a in a sharp reversal, investors pulled $1.3 billion from bond mutual funds last month, according to Strategic Insight. "Treasury (bonds) aren't a very good value," says USAA's Espe. "So where are you going to go?"

His answer, in part, is stocks. He says the S&P 500 could rise 10 percent next year. But, of course, there is another alternative to bonds: cash.

David Wright, manager of the Sierra Core Retirement Fund, is no fear monger. Two and a half years ago, when most people sold stocks and the market hit 12-year lows, he bought heavily. He also loaded up on junk bonds and emerging market bonds.

Now Wright has sold — every last bit of it. He no longer owns stocks or junk or emerging market bonds. Cash is a third of his holdings, up from 12 percent in October.

He says that investors selling bonds won't necessarily jump into stocks. And that's good, since Wright believes economic growth could stall instead of accelerate and that stocks could suffer.

"We've had (nearly two years) of complacency and greed," he says of investors in both bonds and stocks. "But the benefits of government stimulus are gone. This period of good feeling is coming to an end."