Looking past the bad news 

A client recently asked me if money would move back to stocks now that interest rates are so low.

This is a great question from a client who invests mostly in GICs.

I immediately thought of the early 1980's.

For those readers old enough, remember when the risk-free rate of return approached 20% in 1981 - 82? [Editor's note: the prime rate peaked at 22.75% and a 5 year mortgage cost 21.5%]

Back then, the stock market took a major hit as many investors moved their money to short term deposits.

But just as investors were moving the last of their money out of the stock market in 1982, interest rates plummeted and the economy plunged into one of the worst Canadian recessions in history. In retrospect, it was a great time to invest as the stock market rallied strongly as interest rates dropped. The flow of money reversed course and went back into the stock market.

Back to the client's question. If rates are low, will money flow back into the stock market? 

Despite investor pessimism, gloomy journalists and a not so stellar Canadian stock market in 2011, markets were hit out of the blue by a burst of optimism early in 2012. America produced almost two million jobs since last summer (far exceeding expectations) corporate profits overall are very good to excellent and even in Europe, expectations were that some sort of deal would be cut with Greece[1]. Incredibly, General Motors, yes the venerable old Detroit car manufacturer made the most money ever – the same company that was on life support only three years ago. Ford and Chrysler all made money in 2011 too. 

The Dow Jones Industrial Average (DJIA) is close to a 4 year high. The tech heavy NASDAQ index is at its highest level since the year 2000 and the S&P 500 is almost 100% higher than its March 9, 2009 low. There is still more good news. Despite the hysterical headlines about Europe, most of the main indexes in Europe have been in rally mode since last Fall. Some are up more than 20% and Germany is up about 38%. 

My answer to my client's question was this: "Despite the recent stock market rally, many retail investors are not moving significant amounts of money. At least not yet." 

If history is any guide, in a very low interest rate environment due to ZIRP (Zero Interest Rate Policy pursued by the Federal Reserve Bank in the U.S ) money will likely flow back to stocks. Just when - no one knows. Investor sentiment is generally a lagging indicator and given the current levels of pessimism, investors could still be on the sidelines even as the market takes off.