Recession’s impact was frightening, long-lasting

Stocks

including relatively new exchange-traded funds, which investors like because of their low fees.

“People don’t trust the market anymore,” said financial historian Charles Geisst of Manhattan College. He says a “crisis of confidence” similar to one after the crash of 1929 will keep people away from stocks for a generation or more.

The implications for the economy and living standards are unclear but potentially big. If the pullback continues, some experts say, it could lead to lower spending by companies, slower U.S. economic growth and perhaps lower gains for those who remain in the market.

Since they started selling in April 2007, eight months before the start of the recession, individual investors have pulled at least $380 billion from U.S. stock funds, a category that includes both mutual funds and exchange-traded funds, according to estimates by the AP. That is the equivalent of all the money they put into the market in the previous five years.

Instead of stocks, they’re putting money into bonds because those are widely perceived as safer investments. Individuals have put more than $1 trillion into bond mutual funds alone since April 2007, according to the Investment Company Institute, a trade group.

Selling during both a downturn and a recovery is unusual because Americans almost always buy more than they sell during both.

Since World War II, nine recessions (prior to the most recent recession) have been followed by recoveries lasting at least three years. According to data from the Investment Company Institute, individual investors sold during and after only one of those previous downturns — the one from November 1973 through March 1975. And back then, a scary stock drop around the start of the recovery’s third year, 1977, gave people ample reason to get out of the market.

The unusual pullback this time has spread to other big investors — public and private pension funds, investment brokerages and state and local governments. These groups have sold a total of $861 billion more than they have bought since April 2007, according to the Federal Reserve.

Even foreigners, big purchasers in recent years, are selling now — $16 billion in the 12 months through September.

As these groups have sold, much of the stock buying has fallen to companies. They’ve bought $656 billion more than they have sold since April 2007.

On Wall Street, the investor revolt has largely been dismissed as temporary. But doubts are creeping in.

A Citigroup research report sent to customers concludes that the “cult of equities” that fueled buying in the past has little chance of coming back soon.

Investor blogs speculate about the “death of equities,” a line from a famous BusinessWeek cover story in 1979, another time many people had seemingly given up on stocks. Financial analysts lament how the retreat by Main Street has left daily stock trading at low levels.

The investor retreat may have already hurt the fragile recovery.

The number of shares traded each day has fallen 40 percent from before the recession to a 12-year low, according to the New York Stock Exchange. That’s cut into earnings of investment banks and online brokers, which earn fees helping others trade stocks. Initial public offerings, another source of Wall Street profits, are happening at one-third the rate before the recession.

And old assumptions about stocks are being tested. One investing gospel is that because stocks generally rise in price, companies don’t need to raise their quarterly cash dividends much to attract buyers. But companies are increasing them lately.

Dividends in the S&P 500 rose 11 percent in the 12 months through September, and the number of companies choosing to raise them is the highest in at least 20 years, according to FactSet, a financial data provider. Stocks now throw off more cash in dividends than U.S. government bonds do in interest.

Many on Wall Street think this is an unnatural state that cannot last. After all, people tend to buy stocks because they expect them to rise in price, not because of the dividend.

But for much of the history of U.S. stock trading, stocks were considered too risky to be regarded as little more than vehicles for generating dividends.

In every year from 1871 through 1958, stocks yielded more in dividends than U.S. bonds did in interest, according to data from Yale economist Robert Shiller — exactly what is happening now.

So maybe that’s normal, and the past five decades were the aberration.

People who think the market will snap back to normal are underestimating how much the recession scared investors, says Ulrike Malmendier, an economist who teaches at the University of California, Berkeley and has studied the effect of the Great Depression on attitudes toward stocks.

She says people are ignoring something called the “experience effect,” or the tendency to place great weight on what you most recently went through in deciding how much financial risk to take, even if it runs counter to logic. Extrapolating from her research on “Depression Babies,” the title of a 2010 paper she co-wrote, she says many young investors won’t fully embrace stocks again for another two decades.

“The Great Recession will have a lasting impact beyond what a standard economic model would predict,” she said.