I recently wrote about U.S. stocks recovering their valuations after this year's sell-off. However, that doesn't mean the market's rise is over. There is another source of gains that is potentially very large. However, to view it, we need to take a contrarian stance.
Many investors are underweighted in U.S. stocks...
This underweight position should be an accepted fact. Both individual and institutional investors continue to focus on risk, particularly from investing in U.S. stocks. Wall Street has been obliging with new non-stock or hedged-stock products for some time now. And that, I believe, is the cause for the thought that the underweight positions are the new normal.
It's been 2-1/2 years since the stock market hit bottom, and investors should have returned to normal allocations by now. Therefore, many are saying that they have - i.e., that the current allocations are normal for today's new recognition of risks.
Time does not prove a new trend
This allocation belief appears reasonable because it has lasted so long. However, if we dissect those 2-1/2 years, we see that investors did start to rebuild allocations three times.
Each effort was interrupted, though, by basically the same, powerful fears resurrecting themselves - particularly the recurrence of a double-dip global recession and financial meltdown. These three bouts of fears also have come to naught three times. Economic growth continues as does corporate earnings growth. As a result the stock market is up about 100% without investor enthusiasm. That's why the valuations continue to look so attractive in this low interest rate environment.
Therefore, we need to take the contrarian position that it is only a matter of time before investors decide that their fears are misplaced and they begin to rebuild their positions for real.
The bottom line
Keep that contrarian hat on and ignore those arguments of investors being permanently anti-U.S. stocks. The 2-1/2 years of underweighted positioning only mean that the pent-up demand for stocks has grown. When it comes, expect prices to rise faster than earnings, taking valuations back up to their long-term, normal levels.
Disclosure: Long U.S. stocks and U.S. stock funds.
