Investors May Be Expecting Too Little

For a seasoned investor, often the most uncomfortable place to be is in a crowd.

That’s because Wall Street history is filled with examples of bad group-think -- times when the majority view of financial markets’ outlook was dead wrong, and the smart move would have been to bet against the crowd, not with it.

But as author James Surowiecki eloquently wrote in his 2004 book “The Wisdom of Crowds,” the collective decision of a crowd isn’t always a wrong decision. In his research, Surowiecki says he found that “crowds of all sorts were often remarkably wise.”

That’s a bit of context for some results from a recent nationwide poll of investors by The Times and the Bloomberg news organization. The poll found that the majority of people were of one generally upbeat mind on the outlook for the U.S. stock market.

Seventy percent of affluent investors -- defined as those with annual household income of more than $100,000 -- expected to earn the same or better return from U.S. stocks over the next 10 years as in the last 10 years.

More than 80% of affluent investors also thought that this year, specifically, would be an average or above-average year for the U.S. equity market. Just 10% expected this to be a below-average year, which implies that few people are worried that another bear market is looming.

Wall Street pessimists may well be thrilled by poll results like these. The bearish case is that investor complacency is high, meaning that people have been lulled into believing that equities face no serious risks even though this bull market is relatively aged, now in its fourth year.

The majority must be wrong, right?

Except that, drilling down further into the poll’s results, the respondents didn’t sound all that ebullient. The Feb. 25-March 5 telephone survey of 2,563 adults, including 712 classified as affluent investors, showed:

* Just 11% of the affluent group expected to earn more in U.S. stocks over the next 10 years than in the last 10. Fifty-nine percent figured they would earn about the same as in the last 10 years, which they were reminded by poll questioners was a 9% average annual total return on the blue-chip Standard & Poor’s 500 index.

So the giddy, double-digit-return mentality of the late-1990s hasn’t made a comeback in the investment consciousness of people who have significant portfolios (and who, one would assume, pay more attention to markets than those with more modest portfolios).

* Of the more than eight in 10 affluent investors who expected this year to be average or above-average for U.S. stocks, most -- more than six in 10 -- were in the average camp. Just two in 10 predicted above-average returns.

* Of all investors surveyed, not just the affluent, 46% expected to earn 9% or less on their entire investment portfolio in 2006. Thirty-eight percent expected to earn about 10%. A mere 8% expected to earn 11% or more, and another 8% weren’t sure what their return might be.

The poll overall had a margin of sampling error of plus or minus three percentage points; that margin was four points for the affluent investor portion.

To be sure, there’s a case to be made that even a high-single-digit portfolio return could be hard to achieve in 2006. The S&P; 500 returned just 5% last year, including dividends, and the average domestic stock mutual fund gained 6.7%. Long-term Treasury bonds aren’t even paying 5%. Money market fund yields are about 4%.

If those returns are in the ballpark for 2006 as a whole, most people with diversified portfolios would need another big year for foreign stock markets (the average foreign fund rose 17.4% last year) to ratchet up their overall return.

Yet the majority view of a decent year for U.S. stocks in 2006 may not be far-fetched. Friday’s trading activity on Wall Street suggested how investors’ mindset is shifting.

The government’s report on February employment trends showed a larger-than-expected gain in job creation.

That, in turn, pushed up Treasury bond yields, as investors figured that the Federal Reserve would continue to tighten credit. But stocks rallied broadly even as bond yields rose.

Allen Sinai, head of Decision Economics Inc. in New York, says the stock market’s resilience this year, in the face of higher interest rates, makes perfect sense.

Tighter credit, he says, “wouldn’t be happening if economic activity, corporate profits, and growth in jobs and incomes weren’t good.”

All of that traditionally is bullish for equities.

In the Times/Bloomberg poll, affluent investors’ generally confident mood about stocks contrasted with their lack of enthusiasm for bonds.

Asked whether, at current interest rates, bonds were a good or bad investment compared with what might be earned in the stock market over the next year, 49% of the affluent group said bonds were a bad investment. Fewer than one-third said bonds were a good investment; 5% said prospects for bonds and stocks were about the same, and 14% weren’t sure.

The poll respondents might be able to teach a thing or two to the many highly paid analysts on Wall Street who have been insisting for the last year that it was a smart idea to lock in bond yields. Instead, it has been a dumb idea because interest rates have continued to rise.

As for the longer-term view, is it too optimistic to believe that the U.S. stock market could generate a 9% average annual return over the next 10 years?

That would actually be less than the average return of the last 80 years, which was 10.4% a year for the S&P; 500 index, according to data firm Ibbotson Associates.

What’s more, one argument in favor of U.S. blue-chip stocks -- the core of many people’s portfolios -- is that they’ve suffered enough. Consider that the S&P; 500 still is in the red measured since Dec. 31, 1999. The index’s total return, even after dividends are included, is negative 3.9% so far in this decade.

If the S&P; earns 9% a year over the next 10 years, the combined return of that period with the loss of the last six years wouldn’t be a barn-burner.

Which means that the crowd, as measured by the Times/Bloomberg poll, really may not be expecting all that much in its long-term stock return estimate.

So if the assumption is that the majority is wrong, it’s at least worth considering whether they might be wrong because they’re expecting too little from stocks rather than too much.

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Tom Petruno can be reached at tom.petruno@latimes.com. To read the entire poll, visit: www.latimes.com/timespoll.