Stock market: Is the little guy right this time?

Four years after the Great Crash, small investors are suddenly buying stocks again. Is that reason to cheer, or worry?

Mom-and-pop investors spent nearly all of the past four years pulling money out of U.S. stock mutual funds and buying bonds. During the first week in January, they started buying stocks again, according to figures from the Investment Company Institute.

It’s as if Congress, by avoiding the fiscal cliff, sent a “buy” signal across the land.

In some ways, it’s about time. The market has doubled since early 2009, and the little guy missed most of that. But small investors are notorious for rushing in at the wrong moment.

Could they be making that mistake again? Probably not. Or at least not yet.

Stocks were up 5.2 percent, dividends included, in January on top of a 15.9 percent return last year. “We continue to see persistent signs that the S&P 500 has further to climb this year,” write Stuart Freeman and Scott Wren, equity strategists at Wells Fargo Advisors in St. Louis.

They think the S&P 500 will finish the year at between 1,525 and 1,575. Bank of America Merrill Lynch is forecasting 1,600. The big-stock index closed Friday at 1,513.

Earnings are growing, and stocks still look a little cheap. The broad market is trading at 13.7 times this year’s expected earnings. The historical average is 15, notes Kate Warne, investment strategist at Edward Jones in Des Peres. “Valuation is only half the story,” she notes. “We will continue to see earnings growth.”

Despite a stall in the fourth quarter, Warne and most economists see the economy growing about 2 percent this year. That should be enough raise earnings by a “mid-single digit” percentage, Warne says.

Reasonable values and growing earnings bode well for stocks, but there are bumps ahead. This month’s 2 percent increase in the payroll tax is taking a toll on consumer confidence, and Congress may whack government spending in March, which could knock defense stocks for a loop.

After a big rally, a short-term retreat wouldn’t be unusual. Still, trading volumes haven’t been huge, and there’s no sign of the stock-buying mania that can portend a real crash. Though small investors are buying again, they’re not stampeding. In the first three weeks of January, they added $16 billion to American stock mutual funds. In December, they pulled out $26 billion.

The little guys also enjoyed short periods of optimism in early 2011 and 2009, only to sink back into an anti-stock funk.

It could be different this time.

Analysts at Bank of America Merrill Lynch think we’re seeing a “great rotation” of investors out of bonds and into stocks. Small investors spent the past four years piling into bonds, and they enjoyed nice profits as interest rates sank. Now, analysts warn that the bond gravy train may be headed for derailment.

The Federal Reserve has the bond market on life support, pumping $85 billion a month into mortgage and Treasury bonds to hold rates down. Dread the day when Chairman Ben Bernanke pulls the plug.

The Fed says it will keep the patient breathing until the unemployment rate approaches 6.5 percent. That’s probably at least a year away, although some Fed officials have suggested easing up on the bond buying later this year. The bottom line: Bond investors may be safe for several more months, but those who hang on too long risk unpleasantness. A 10-year bond would lose about 7.4 percent of its value if interest rates rose by 1 percentage point. A five-year bond would lose 4.3 percent.

Meanwhile, there’s less fear in the stock market. The fiscal cliff is behind us. There’s less worry about a financial meltdown in Europe, although the continent is still in recession. Merrill Lynch sees stocks worldwide returning about 10 percent this year, while investment-grade bonds return a mere 1.6 percent.

Some small investors have their own market gauges. Joe Jennings of Dardenne Prairie talks to many senior business executives in his job with a litigation support company. “How’s business?” he’ll ask them.

“I’m not hiring,” they’ll often say. “I can’t raise prices and I can’t pass on my costs.”

Jennings believes in the stock market. He bought heavily after the 2008 crash. But with stocks once again near their all-time highs, the pessimism he hears in his clients makes him wary. He doesn’t like the news that small investors are buying stocks again.