Investors are treating Wall Street like Detroit

It was only a decade ago that the U.S. stock market was considered the place where average Joes could achieve the American Dream, much like workers viewed Detroit’s once-gleaming auto industry. But after the technology bubble burst in 2000, the market’s reputation was tarnished — and folks started to favor flashier foreign stocks instead.

That may have been understandable back then, since U.S equities weren’t just laggards following the tech crash; they were still pricey to boot. But how do you explain what’s going on today?

This year, the market has been mired in a panic triggered by a European debt crisis that has sent foreign equities tumbling to double-digit losses year to date (versus the S&P 500’s breakeven performance). Yet according to figures released late last week by the Investment Company Institute, individual investors aren’t punishing foreign portfolios. Rather, they’re taking it out on U.S. stock funds. While investors have poured $27 billion of net new money into foreign equity funds this year, they’ve yanked $20 billion out of better-performing domestic equity portfolios.

“You would think it would be the opposite,” says Mike Scarborough, president of Scarborough Capital Management, an investment advisory firm in Annapolis, Md. “You almost have to wonder whether investors are starting to treat U.S. stocks like they do U.S. autos.”

In other words, after years of poor performance, U.S. stocks, like American cars, are having a tough time convincing investors that they’re now a good buy — no matter how many studies or statistics support that case.

Yet if investors were to look under the hood, they’d see that “the case for U.S. stocks is pretty decent” — at least relative to other equities, says James Paulsen, chief investment strategist for Wells Capital Management. For starters, the U.S. economy is expected to grow around 3% a year on average between now and 2015. While that’s not China fast, it represents a much greater pace of growth than the rest of the developed world, especially Europe.

What’s more, U.S. equities have held up better than foreign stocks since the financial crisis began in October 2007. Since then, the S&P 500 has lost around 9.8% a year, versus annualized losses of 11.7% for the rest of the world and 15.4% for Europe.

And while U.S. and European corporate profits are both expected to grow around 30% in 2010, U.S. shares are trading at a slight discount. The price/earnings ratio for the S&P stands at around 13 (based on estimated 2010 earnings), versus 13.5 for a leading Euro-centric foreign stock index.

“But none of that seems to matter to investors now,” says Paulsen, because “the reputation for U.S. stocks has definitely been dented.”

Speaking of dented, we're back at the Detroit automobile metaphor: Is investors' distaste for U.S. stocks a justified reaction to poor-quality goods? Or is it a case of perception not having caught up to a new reality of higher value? Your comments are welcome.

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