Room to Grow: Sentiment Augurs More Market Gains: Searching for Alpha for October 2010

Last month’s Searching for Alpha newsletter listed several reasons why I feel stocks are heading higher.  Even after a spectacular September, the market looks poised for further gains.

Besides valuation and low interest rates, the biggest positive in favor of equities is the current state of investor sentiment. According to the Investment Company Institute (ICI), only 30% of mutual fund investors were willing to take “substantial or above-average risk” in May 2010.  In 2008, the number stood at 37%.

According to the ICI, the decline in risk tolerance was “widespread across working age mutual fund investors.”  Meanwhile, the more well-to-do older demographic continues to shy away from risk at a much great pace than younger market participants.

What this means, of course, is that the average do-it-yourself investor is missing the current rally. As stocks heat up, the retail crowd will succumb to the buying pressure, pushing stocks up even higher. The trick is to make the move ahead of this pile of cash.

It’s likely that much of the liquidity needed to buy will come from government bond funds.  Investment advisors are cautioned to add to such positions carefully in the coming months.