During my career as an investor, I’ve lived through three stock-market crashes: 1987, 2001 and 2008. Many of my clients have lived through them, too. Each crash was preceded by overconfidence and followed by reluctance on the part of retail investors. Getting them back in the market was your task, and you worked hard and long to do it.
Today, as we are once again bouncing around all-time highs in the stock market, a lot of people have portfolios that are very heavily weighted to equities. It’s hard to know what to do. The market could keep going up. What’s more, with low interest rates, where else do you put the money? Is the bull market more about fundamentals or about lack of an alternative? Are we bidding prices up because interest rates are not where investors need them to be?
Activity in the high-yield market indicates that, yes, people are still in the stock market because there are few other places to go for yield as well as long-term growth. And risks have escalated with prices. We’re looking at a lot of geopolitics. There were a couple of times in 2015 and 2016 that the market went down sharply, then bounced back. You can see in those periods that people were switching out of the market owing to political events like the brinksmanship over the debt ceiling and uncertainty over the presidential election. When equities ticked back up, investors stayed out for several months nevertheless.
Now, it’s anxiety time. The market is rich, and could keep going—but people believe in the law of gravity and that eventually it will fall. People who say a bull market lasts five to seven years are several years short of today’s nine-year rise. It’s hard to know what to think.
What we do know is how people actually behave, because we have the activity of more than 10,000 investors documented in our investment platform. We decided to analyze this data and create an index of exposure to the stock market so we could track investor behavior. The Emotomy Exposure Index is a bit like a sentiment indicator—you get a sense about how clients have invested their money across different sectors and can intuit from that how confident they are in the future. We scan clients’ accounts and aggregate their investments in stocks, bonds, cash, commodities and other uncorrelated assets, and get a sense of their appetite for risk. The Index is posted on our website daily for all to see.
Over time, the Exposure Index may give us predictive information but for now we are analyzing what exposure is and how we can use it. Here are our initial thoughts:
1. Exposures have been flat or falling while the market is rising. The Exposure Index is at 67.3 as of mid-November, compared to 73 on June 1, 2017. People may be reducing or rebalancing their allocations. A lot of people sort of follow models but not systematically, so some of this drop may be the result of rebalancing to a model. Nevertheless, it’s clear that stock exposure is not rising, despite the rising market. Some people may just be cautious, having lived through bubbles and the carnage that follows.
2. Exposure appears to be a lagging, not a leading or coincident, indicator. Unless you have a portfolio where the volatility of stocks in itself is an allocation, the more stocks, the more bullish the investor. You would wish stock purchases were a leading indicator, but then you’d believe that investors have a crystal ball. The fact is, the more exposure retail investors have, the frothier the market. If you’re cynical, exposure is a counter indicator. Risk is higher. But sometimes investors are right for many years and have a good ride.
3. Talking to your clients about risk requires tools. Several software firms have sprung up with great risk tools that can spur discussion with clients. Riskalyze, for instance, gives you a “risk number” for a portfolio; Hidden Levers stress tests a portfolio against various economic and political events; Finametrica probes your clients’ risk tolerance and capacity.