The year 1999 was a very unique period. There was an overwhelming consensus that the “new economy” was a permanent investment theme that couldn’t be stopped. The valuation of technology, media, and telecom companies were bid to extreme valuations. Investors and pundits openly ridiculed observers, like me, who disagreed with the new era’s sustainability. Active managers were criticized for not being able to keep up with benchmarks even though it might have been irresponsible for a fiduciary to concentrate a portfolio in a single sector. Dividends were thought of as a lead weight on portfolio performance. Of course, the Tech bubble deflated, and investors suffered from being so myopic.
Investors appear similarly short-sighted today. However, they are not rabid for capital appreciation as they were in 1999. Rather, they are rabidly risk averse and always scared that a replay of 2008’s bear market is lurking. That has led to valuation distortions of historical proportions among “safe” investments that outperformed in the wake of 2008.
Many have claimed that the rush for income investments is demographic. While the aging of the baby boomers may partially explain some risk aversion, it certainly doesn’t fully explain these extreme distortions. Data increasingly suggest that fear is motivating investors’ search for safe income. We continue to believe that “octogenarians will be screaming for capital appreciation” when the stock market peak truly forms.
Safe investments are safe until everyone wants them. Once they become popular, safe investments can become quite risky. That shift from conservative to aggressive is already starting to happen. 2015’s MLP debacle and the current problems in UK property funds may be the proverbial canaries in the mine shaft with respect to the riskiness of single-mindedly investing for income, but so far income investors generally appear oddly complacent. Much as the fear of missing out on riches clouded investors’ rationality in 1999, the fear of losing money is causing an overwhelmingly risk averse environment.
Most investors disagree with this assessment. They argue that investors are too bullish because the stock market is vastly overvalued and the economy is on the precipice of recession. In this report, we show data that seems to strongly refute those contentions. Investors, by our reckoning, are extremely risk averse when it appears that the worst of the profits recession is already behind us.
Wall Street scared
For nearly 30 years, we have surveyed Wall Street strategists for their recommended equity allocation. Through time this survey has shown to be a very reliable long-term sentiment indicator. In other words, it has historically been bullish when Wall Street suggested underweighting equities and bearish when they suggested overweighted positions.
Chart 1 shows this historical survey relative to the standard long-term 60-65% neutral benchmark weight. There are several critical points that emerge from this chart:
1. Wall Street recommended underweighting equities throughout most of the bull market of the 1980s and 1990s. This represents the proverbial “wall of worry” that existed throughout that secular bull market.
2. Wall Street recommended overweighting equities in 1999/2000 just prior to the “lost decade in equities”.
3. Wall Street again favored equities prior to the 2007/8 bear market.
4. Most important, strategists have been again recommending an underweight of equities throughout the current bull market.
The notion that investors are overly bullish seems directly counter to these data. If investors are so incredibly bullish, then they obviously must be bullish counter to the recommendations of their advisors. How many investors, whether individual or institutional, have actually said, “I don’t care what my advisor or consultant says about being cautious. We need to be fully invested in US stocks.”? We strongly think the answer is none.
Rabidly Risk Averse
July 13, 2016
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