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Brett Arends’s ROI: Why all of this bearishness could actually be great news

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The best news for investors that I’ve heard in a long time is that the M.B.A. geniuses who manage the world’s pension funds now hate the stock market with a vengeance.

According to the latest comprehensive survey by BofA Securities, global investment managers are now at historic, generational levels of bearishness and gloom. Bank of America surveyed around 300 money managers around the world handling about $900 billion in assets. Depending on how you measure it, they are now as bearish about stocks as they were during the Covid crash two years ago, the depths of the global financial crisis in late 2008, the run-up to the Iraq war in 2003, the weeks after 9/11 in 2001, and the global financial crisis of late 1998.

What does this mean for you and me, retirement savers?

Everything that needs to be said about forecasting was either said by the late, great New York Yankees manager Casey Stengel (“Never make predictions, especially about the future”) or by the banker J.P. Morgan Sr., who when asked for his stock market forecast replied that he expected share prices to fluctuate.

But if the past resembles the future, the latest survey results are bullish. That’s especially true the further you are from the stock market, the less you follow it day to day, and the more you are a regular Main Street investor who puts some money into their 401(k) or IRA at the end of every month.

Out of curiosity I went back and looked at the eight previous occasions in the last 25 years when, according to BofA Securities surveys, global money managers were about as bearish and pessimistic on stocks as they are now. (Before 2008 the survey was conducted by Merrill Lynch, which was then taken over by Bank of America.)

And I looked at how you would have fared if, in each of those months, you had just gone out and invested $10,000 in the S&P 600
SML,
-0.66%

index of small U.S. company stocks and then just held them for five years, which is about the minimum recommended investment horizon for an ordinary investor. (I omitted March 2020, as it’s too recent.)

Net result?

Your average return over the next five years would have been just over 100%. In other words, you would have doubled your money.

By doing nothing more than buying a small cap index fund when fund managers were really, really pessimistic, and then hanging on for five years.

The worst five year return was 60%, which followed the 2008 financial crisis. The best was 160%, which followed the 2008 financial crisis. In not one case did you lose money. In six cases out of eight you doubled it or better.

Why did I choose small-company stocks? Well, you can use any broad stock market index and the results will be at least comparable. But small-company stocks tend to be more volatile than large-company stocks, so that they fall more in a panic and rise more in a boom. As a result, they tend to be the best way to make a contrarian bet. The time to buy small-caps is in a crisis, when everyone else is too afraid.

The Russell 2000
RUT,
-0.37%

is the more widely followed index of U.S. small-company stocks, but the S&P 600 is generally more appealing. It weeds out a lot of low-quality, speculative and loss-making small companies. And there is evidence that among small-company stocks, at least, you want to stick to the higher quality companies.

As usual, I’m just passing on information that long-term investors may find useful. What you do with it is up to you.

Those wishing to take this bet have many low-cost index funds from which to choose, including the iShares Core S&P Small Cap ETF
IJR,
-0.37%

for the S&P 600 and Vanguard Russell 2000 ETF
VTWO,
-0.24%

for the Russell.

If you use the S&P 500 index
SPX,
-0.36%

of large-company stocks, by the way, the five-year returns still worked out generally very positive, but not quite as good. And in one of the eight occasions—July 2000—buying an S&P 500 index fund like the SPDR S&P 500 ETF
SPY,
-0.34%

and hanging on for five years still ended up losing money (even if only 5%). That’s because at the time a massive bubble in large-company stocks was still just starting to unwind. (Some people argue we are in a similar situation regarding U.S. large-caps today.)

The latest BofA survey also shows money managers are especially underinvested in bonds, Eurozone stocks, emerging markets stocks, technology stocks and consumer discretionary stocks. If that doesn’t turn out eventually to be bullish for the relevant ETFs—such as, say,
AGG,
+0.39%
,
EZU,
+0.43%
,
VWO,
+1.13%
,
QQQ,
+0.21%

and
XLY,
+0.57%

—I will be very surprised.

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