Prudential: Small Investor Is Back

Updated from 11:55 a.m. EDT

Recent weakness in stocks hasn't kept Prudential Securities from casting its lot with those calling a retail investor recovery.

On Tuesday, Prudential upgraded Merrill Lynch (MER Quote) and Morgan Stanley (MWD Quote) to buy from hold, citing a faster-than-expected rebound in individual investor activity.

"While we do not expect a return to bubble-period fervor, we believe signs that recovery will happen are numerous," said David Trone, an analyst at Prudential, in a research note. He raised his price target for Merrill to $54 from $47, and increased his price target for Morgan Stanley to $51 from $47. Prudential has had an investment banking relationship with Morgan Stanley in the past.

Merrill closed up 92 cents, or 2%, at $46.64 on Tuesday, while Morgan Stanley rose 49 cents, or 1.1%, to $43.30.

As evidence of a resurgence by small investors, Trone noted that Charles Schwab (SCH Quote) said its retail brokerage activity increased in May. Also, the Investment Company Institute estimates retail equity mutual funds saw $16 billion in net inflows in April, following outflows in nine of the 10 previous months.

According to AMG Data Services, there have been five consecutive weeks of inflows into U.S. registered open-end equity funds through the week of June 18, the first such streak since March 2002. That compares with the bubble era, when AMG recorded a nine-week stretch of inflows between February and April 1998 and a 15-week run from December 1999 through March 2000.

Since March, the Dow Jones Industrial Average has gained 16%, the Nasdaq Composite has tacked on 21%, and the S&P 500 has added 17%. Stocks have given back some of those gains this week, as investors have showed apprehension about the market's advance.

"We recognize a sustained rebound in the retail investor confidence and activity is far from assured. Also, with the strong three-month rally in the major indexes, some improvement was naturally going to result," said Trone. "However, in any context, we must concede it has responded much quicker than we had expected ... Those with the money seem to be comfortable boosting their allocation to equities."