Why Investors Should Be Bullish on Stocks Now

BOSTON ( TheStreet) -- Retail investors are turning more bearish on U.S. equities, according to the latest data on sentiment and mutual fund flows, but one market strategist says it is time to be greedy now that others are fearful.

Investor sentiment worsened last week, according to a survey by the American Association of Individual Investors. The AAII Investor Sentiment Survey, which measures the percentage of individual investors who are bullish, bearish and neutral on the stock market for the next six months, showed that bearish sentiment rose 1.4% in the week ended July 20. That compares with a 0.5% rise in bullish sentiment and 1.9% decline in neutral sentiment.

Mutual fund flow data also show retail investors are steering clear of U.S. equities. The Investment Company Institute estimates that equity funds saw total outflows of $3.4 billion in the week ended July 13. Foreign equity funds had an estimated increase of $648 million, while domestic equity funds saw more than $4 billion drain out over the week.

The most startling statistic is that U.S. equity funds have now seen outflows of more than $3 billion in each of the past six weeks. In the week ended June 15, more than $6.8 billion flowed out of domestic equity funds, according to ICI's data.

Despite these massive outflows from equity funds, long-term mutual funds saw $2.47 billion in total inflows overall, according to ICI's estimates. With tepid economic growth and unemployment ticking higher, the soft patch in the economy has driven investors from equities into less riskier investments such as bonds.

Bond fund inflows totaled nearly $5.3 billion. Even without a deal in place to increase the debt ceiling and keep the U.S. from a technical default, investors are seeking the safe haven of the bond market. While the S&P 500 is up more than 1% today, the index has added less than 2% this month and just under 7% this year. The yield on the 10-year Treasury, meanwhile, has dropped from about 3.75% in February to less than 3% today.

"The equity outflows are unsurprising because of the soft patch of the economy and also because the stock market has been in a trading range since February," says Jim Paulsen, chief investment strategist with Wells Capital Management, an investment firm with assets of more than $350 billion. "It shows that people have caught up to what's happened in the rearview mirror."

Paulsen says it's understandable that retail investors are skittish about stocks and are finding safety in bonds. "During this soft patch, people have been told nothing except that the economy has really slowed down. There's been a lot of hype on the debt ceiling and the potential downgrade. There's been a lot made out of Europe. It has its impact," he says.

But as the old Warren Buffett proverb goes, be fearful when others are greedy and be greedy when others are fearful.

"When everyone leaves the market, oftentimes it's a great indication that you're ready to go on another run in the market," Paulsen says. "People get scared and they make adjustments. If anything, it's a precise signal that it's the end of the soft patch. The fact that you're seeing some fund flows out is another sign that we're closer to the point of where we take off again."

Investment-research firm TrimTabs cautions that there may be little time left to play the contrarian angle. TrimTabs' data show U.S. equity mutual funds went from taking in $11.3 billion in January to redeeming $21 billion in June. The flows have stopped deteriorating, though, which gives the firm pause.

"Although they are still bleeding, the relatively light month-to-date outflow of $6.5 billion suggests the deterioration has halted," TrimTabs researchers wrote in a report Wednesday. "Less hate from mom and pop should displease bullish participants because retail investors tend to time the market poorly."

Even so, Paulsen says the situation now is the exact opposite of what happened earlier this year, when inflows to domestic equity funds totaled $11.5 billion and $9.3 billion in January and February, respectively, according to data from ICI.

"That was the top of the market, and it's no coincidence that the economy was good and people were feeling better," Paulsen says. "They were going into equities, and that wasn't a good sign. That was the start of the choppiness that started in mid-February."

-- Written by Robert Holmes in Boston.

>To contact the writer of this article, click here: Robert Holmes.

>To follow Robert Holmes on Twitter, go to http://twitter.com/RobTheStreet.

>To submit a news tip, send an email to: tips@thestreet.com.
Disclosure: TheStreet's editorial policy prohibits staff editors, reporters and analysts from holding positions in any individual stocks.

If you liked this article you might like

Paradigm Opportunity Protects Investors in Tough Times

Paradigm Opportunity Protects Investors in Tough Times

5 Things You Need to Know Before the Stock Market Opens (Correct)

5 Things You Need to Know Before the Stock Market Opens (Correct)

U.S. Investors Brace for a Third Bailout in Greece

U.S. Investors Brace for a Third Bailout in Greece

5 Things You Need to Know Before the Stock Market Opens

5 Things You Need to Know Before the Stock Market Opens

40 Hedge Funds' Best Stocks Show the Way for 2012 (Update 1)

40 Hedge Funds' Best Stocks Show the Way for 2012 (Update 1)