Smarter than the average bear?

• Author: Hensel, Katherine
• Position: Stock market will continue to rise - Column

NO SOONER had individuals finished putting record amounts of money into equity mutual funds in 1993, when some market commentators began warning that this reflected far too much enthusiasm for stocks and was a worrisome sign that the market had peaked. Was this just another case of poor timing from a group that market lore says is known for its bad timing? The unsettled market this year seemed to confirm the view of some pundits that individuals' interest in stocks had reached extreme and possibly unhealthy levels.

However, individuals can have more faith than that in their investment instincts. The market's difficulties are rooted in a short-term cause, clearly linked to rising interest rates. The uncertainty about the extent to which the Federal Reserve would raise rates, and what effect this would have on economic growth, have made 1994 a difficult year for many investors, but that uncertainty will not overhang the market in 1995 or 1996.

The strong move among individual investors into stocks that began in 1991 when yields on bank certificates of deposit plummeted is hardly an example of a trend being carried too far. A close examination of the history of household investment suggests that, in the past, individuals have demonstrated some shrewd timing in making their entrances to and exits from the market. The record also suggests individual investors will continue placing money in stocks for many years to come.

Past periods in which individuals either participated heavily in the stock market or stayed away, exhibiting marked indifference, persisted for about 20 years. In the late 1950s and early 1960s, households had roughly 40% of their discretionary financial assets in equities. Ownership peaked in 1968 at 45%. By 1974, discretionary financial assets dropped to roughly 18%.

The late 1960s and 1970s was an era of generally accelerating inflation. In addition, from 1968 until 1980, there were a series of increases in marginal income tax rates. Individuals, showing considerable financial acumen, understood that such changes in the economy heightened the value of inflation hedges and tax shelters. For many, their home served both functions ideally. The result was that, for most of the 1970s, individuals shifted balance sheet assets into real estate and away from stocks. Household tangible assets, representing 33% of total household assets in 1968, rose to 43% by 1978, before beginning to tail off in the 1980s.

From an investment...