Individual investors increased their stock and stock fund holdings last month, according to the April AAII Asset Allocation Survey. Allocations to equities and equity-based funds rose 1.5 percentage points to 62.9%. This was the seventh consecutive month that stock and stock fund allocations were above their historical average of 60%.

Fixed-income allocations fell 2.0 percentage points. Individual investors held 18.6% of their portfolios in bonds and bond funds. Even with the decrease, April marked the 23rd consecutive month that fixed-income allocations were above their historical average of 15%.

Cash allocations edged up 0.5 percentage points to 18.5%. April was the 10th consecutive month that cash holdings were below their historical average of 25%.

Despite last month’s changes, equity and fixed-income allocations remained largely within the range that has existed since last November. The relative level of stability in portfolio holdings is not surprising given that our Sentiment Survey has been showing a cautious level of optimism, with both bullish and bearish sentiment near their historical averages. continue »

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By Jean Folger

Gold has been considered a currency, commodity and investment for thousands of years. Sought after for both its beauty and worth, gold continues its rally to reach new daily highs.

There is speculation among anxious investors about just how high gold could go. While no one knows for certain, there is a strong argument in favor of gold climbing even higher.  (For more on investing with gold, check out Getting Into The Gold Market.)

First, let’s look at the factors that drive gold prices.

Central Bank Reserves
Central banks keep paper currency and gold in reserve. For the first time in decades, central banks have begun buying more gold than they are selling, according to the World Gold Council.  As these banks move away from paper currencies and towards gold, they in effect remove a significant of supply from the international gold market, driving the price of gold higher.

U.S. Dollar Value
Gold and the U.S. dollar have an inverse relationship. As the dollar gains strength, the price of gold drops; when the dollar weakens, the price of gold rises. This correlation is due to investor habits. When the dollar is strong, investors will trade in dollars; when the dollar is weak and during times of economic uncertainty, more investors look to gold as a safe haven for their investment activity. This wealth protection measure is used as a hedge against currency devaluation, inflation or deflation. continue »

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By Richard Cloutier, Jr., CFA

Throughout history, free market societies have gone through boom-and-bust cycles. While everyone enjoys good economic times, the downturns are often painful.

The Federal Reserve was created to help reduce the injuries inflicted during the slumps and was given some powerful tools to affect the supply of money. Read on to learn how the Fed fights recession. (To find out more about recession, see Recession: What Does It Mean To Investors? and Recession-Proof Your Portfolio.)

The Evolution of the Fed
When the Federal Reserve System was established, its founders did not intend it to pursue an active monetary policy to stabilize the economy. The basic ideas of economic stabilization policy were foreign at the time, dating only from John Maynard Keynes’ work in 1936. Instead, the founders viewed the Fed as a means of preventing the supplies of money and credit from drying up during economic contractions, as happened often in the pre-1914 period.

One of the principal ways in which the Fed was to provide such insurance against financial panics was to act as the “lender of last resort.” That is, when risky business prospects made commercial banks hesitant to extend new loans, the Fed would step in by lending money to the banks, thus inducing banks to lend more money to their customers. (To learn more about the Fed, see The Federal Reserve.) continue »

With stocks overvalued fundamentally and overbought technically, it appears that 2011 could be a repeat of 2007. Too bearish? I believe investors need to keep their eyes on the housing market and its continued drag on our banks—especially the community banks. As a rule, many of these institutions remain overexposed to Commercial Real Estate (CRE) loans.

People are generally familiar with the fact that Wall Street and the largest financial institutions got hurt by toxic mortgage-related securities, but they sometimes forget that Main Street and the smaller regional and local community banks remain stuck with the hard assets of incomplete housing and other community-related construction projects.

The FDIC closed five more small community banks on Friday. This brings the 2011 year-to-date total to 39. Since the end of 2007, the FDIC has seized 361 banks. This is in line with my prediction that before this crisis is completely over, we will see 500 to 800 bank failures—I do not think we will see the last institution closed until late 2012 or even 2013.

Community banks are the focus of the crisis these days because they did not get the help that the bigger regional banks received in the 2008 Wall Street Bailout. The smaller banks remain overexposed to a variety of legacy real estate loans such—as construction & development, multi-family, nonfarm and nonresidential (all of which are classified as CRE by the FDIC.)

According to the latest FDIC data, 2,623 community banks are overexposed to CRE loans, and 4,479 have a Loan Pipeline that’s 80% to 100% funded. “Pipeline Risk” is the ratio of CRE loans outstanding versus CRE loan commitments. A healthy pipeline is at 60% as loan payments are made. At that level there is additional capital available for builders and developers. However, once a bank has a pipeline at or in excess of the 80% metric, lending standards are made tougher and credit dries up.

When I analyze FDIC loan exposure data lately, I find that while bigger regional banks retain considerable exposure to CRE loans, the ratios to risk-based capital are much lower and thus are not considered a threat.

However, some of the bigger banks in the Regional Banking Index (BKX) do have these legacy loan issues, which is one reason why the BKX is down 1.3% year-to-date with the S&P 500 up 8.4%. If we take a more historical view, we find that the BKX lags as well since it remains 57.5% off its February 2007 high while the S&P 500 only lags its October 2007 peak by 13.5%.

Let’s take a look at several large regional banks—some of which are deigned “too big to fail”—which are not overexposed to CRE loans but do have sizable enough exposures to pose a drag on future earnings. Each of these banks has a HOLD rating according to ValuEngine.com, and most are trading above their one-year price target.

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Filings for initial public offerings (IPOs) this month are at a four-year high, another sign of the stock market’s strength. Renaissance Capital, which compiles data on IPOs, counted 31 filings in April, the most for a single month since August 2007. Year-to-date, 82 companies have filed to go public, putting 2011 on pace to match last year’s total of 257 filings and making it the second busiest year since 2007, when 299 filings were registered.

The IPO market is notoriously fickle, and merely filing with the Securities and Exchange Commission (SEC) does not ensure that a public offering will be completed. Therefore, it is also useful to look at how many offerings have actually been priced, the total dollar volume of the offerings, and how many offerings have been withdrawn. Year-to-date, 49 offerings have been priced, again putting 2011 on pace to match last year’s total. Dollar volume, a measure of the total size of the deals, is at $17.8 billion, or 46% of last year’s total. Withdrawals are also pretty close to last year’s pace, with 15 deals pulled year to date.

These are good signs in that they show that there is an appetite for equities and that corporations are able to raise cash. Unfortunately, the IPO market is a lagging indicator when it’s strong and a reactionary indicator when it’s weak. Would-be public companies take advantage of good market conditions to maximize the money they might raise. Many companies, and their investment bankers, are also quick to wait when stock market conditions get weak. Therefore, the strength or weakness of the IPO market does not provide much of a signal for where stock prices are headed.

In terms of individual IPOs, it is critical to evaluate each one separately. continue »

In recent years, throngs of investors have piled into emerging market exchange-traded funds, with many seeking to diversify their portfolios by investing in a broad swath of emerging market companies. But, according to a new study, emerging market ETFs may actually have the reverse effect.

The study, performed by The Brandes Institute, found that many emerging market ETFs are far more concentrated than many investors realize. “The number of companies available for investment in emerging markets is greater than that in developed markets, reflecting vast opportunity,” the study states. “Yet, the indices (and ETFs tracking these indices) designed to reflect emerging markets tend to be heavily concentrated in just a handful of companies…Many passive investments are, in fact, extremely concentrated owing to the disproportionate size of their largest holdings and blindly weighting by market capitalization.” continue »

Bullish sentiment rebounded 5.7 percentage points to 37.9% in the latest AAII Sentiment Survey. Optimism that stock prices will rise over the next six months remained below its historical average of 39% for the second consecutive week.

Neutral sentiment, expectations that stock prices will remain essentially flat over the next six months, fell 5.4 percentage points to 31.5%. The decline brought neutral sentiment back close to its historical average of 31%.

Bearish sentiment, expectations that stock prices will fall over the next six months, declined 0.3 percentage points to 30.6%. Even with the small drop, bearish sentiment has been essentially unchanged during four out of the last five weeks. The historical average is 30%.

Individual investors continue to be cautiously optimistic. Better-than-forecasted earnings and rising stock prices are keeping many optimistic, while inflationary pressures and the uneven pace of the economic recovery remain a concern.

This week’s special question asked AAII members whether they thought the stock market is fairly valued, undervalued or overvalued. continue »

The S&P 500’s valuation was the source of some debate before the hubbub about the negative watch rating on U.S. sovereign debt took over. While the federal deficit is a problem that needs to be dealt with, stock valuations are more likely to have a shorter-term impact on your portfolio. (This, of course, assumes that Congress raises the debt ceiling. The debt market is currently acting as if Democrats and Republicans will reach some type of agreement.)

The bears have pointed to Yale economics professor Robert Shiller’s cyclically adjusted price-earnings (CAPE) ratio. This valuation measure, which is based on the last 10 years of inflation-adjusted earnings, currently calculates the S&P 500’s price-earnings ratio (P/E) to be 23.47. (Shiller calculates the CAPE ratio as of April 8 using estimated inflation data for March and April.)

Mark Hulbert, editor of the Hulbert Financial Digest and a speaker at this year’s AAII Investor Conference, says the ratio is now 43% above its historical average. He further identified four previous periods when the ratio was at similarly high levels and notes that stocks did not fare well afterward. To be fair, Hulbert does note that he was looking at a small sample size and that there have been instances where the CAPE ratio has stayed at high levels before a bear market set in.

The other thing that has the bears roaring is the valuation of the Russell 2000. This small-cap index is trading at a trailing 12-month (TTM) P/E multiple of 27.3 and a forward-looking (earnings over the next four quarters) P/E of 18.8 (as of Wednesday’s close). Not exactly cheap by either measure. continue »

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This week’s earnings reports come on top of a huge rally for stocks. The Dow Industrial Average traded to a new multi-year high last Friday at 12,506.06, which is above my monthly pivot at 12,481. Meanwhile the NASDAQ remains shy of its February 18 high at 2840.51 and this month’s risky level at 2898. The Dow is up 8.0% year to date with the NASDAQ up 6.3%.

I believe that the catalyst for the most recent run up was the surprise from Intel–which is a very important stock to watch and trade since it plays a role in the Dow as well as the S&P 500 and NASDAQ 100.

This week, I handicap three stocks trading at or near all time highs–Amazon, Caterpillar and Chevron–plus Microsoft, that in recent years has been a perennial laggard. Amazon.com, Microsoft and Chevron are rated a BUY according to ValuEngine.com while Caterpillar is only rated a HOLD. I think that Caterpillar’s earnings may not live up to global demand hype with construction spending in the United States down 8.8% year-over-year in February.

Amazon.com (AMZN) ($185.89) reports quarterly results after the close on Tuesday and the stock is positioned between a test of its 50-day simple moving average a week ago at $176.40 and its all time high set on January 18 at $191.60. ValuEngine.com rates the stock a BUY with a one year price target at $196.78. My buy and trade parameters are between my semiannual value level at $176.78 and my quarterly risky level at $205.20. Investors who have held Amazon for the long term should book some profits and reduce holdings by 50% with the stock trading near its all time high.

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Bullish sentiment plunged 10.1 percentage points to 32.2% in the latest AAII Sentiment Survey. The percentage of investors who expect stock prices to rise over the next six months is at a five-week low. This is also the first time in four weeks that bullish sentiment is below its historical average of 39%.

Neutral sentiment, expectations that stock prices will remain essentially flat over the next six months, soared 10.1 percentage points to 36.8%. This is the highest neutral sentiment has been since March 4, 2010. It is also the first time in five weeks that neutral sentiment has been above its historical average of 31%.

Bearish sentiment, expectations that stock prices will fall over the next six months, was unchanged at 31.0%. The historical average is 30%.

The sharp increase in neutral sentiment follows modest decline in stock prices and a continued climb in gasoline prices. Though bullish sentiment has been above its historical average for the last three weeks, optimism among individual investors has been cautious. Corporate earnings, a rebounding economy and the stock market’s rally have given individual investors hope, while the sluggish labor market, rising gasoline prices, federal deficit and global events are ongoing sources of concern.

This week’s special question asked AAII members how much impact the political wrangling about the federal deficit ceiling was having on their sentiment toward stocks. continue »