Our latest sentiment survey was open from 7/30/10 to 8/6/10. The response rate was much lower than last survey’s, coming in at 113. Your input is for a good cause! If you believe, as we do, that markets are driven by supply and demand, client behavior is important. We’re not asking what you think of the market—since most of our blog readers are financial advisors, we’re asking instead about the behavior of your clients. Then we’re aggregating responses exclusively for our readership. Your privacy will not be compromised in any way.
After the first 30 or so responses, the established pattern was simply magnified, so we are comfortable about the statistical validity of our sample. Most of the responses were from the U.S., but we also had multiple advisors respond from at least two other countries. Let’s get down to an analysis of the data! Note: You can click on any of the charts to enlarge them.
Question 1. Based on their behavior, are your clients currently more afraid of: a) getting caught in a stock market downdraft, or b) missing a stock market upturn?
Chart 1: Greatest Fear. Client fear continues to dominate our broad sentiment index. 92% of clients were fearful of a downdraft, just off the all time highs of 94.7%. The market has rallied for 4 weeks straight now, which has had a negligible effect on client fear levels. Using the survey data points, the market has rallied +7.7% since recent lows in July, but client confidence has not been restored in the slightest. How big of a rally is needed to get Joe Investor back in the market…10%…25%…50%? On the other side, we have the fear of missed opportunities stuck down below the 10% line, near all-time lows at 8.0%.
Chart 2. Greatest Fear Spread. Another way to look at this data is to examine the spread between the two groups. The spread remains significantly skewed towards fear of losing money this round. This survey’s reading was 82%, a hair lower than last week’s reading of 84%. Again, even despite a respectable rally over the month of July, client sentiment remains entrenched in the fear camp. What’s it going to take to get retail investors willing to risk their savings in the stock market?
Question 2. Based on their behavior, how would you rate your clients’ current appetite for risk?
Chart 3: Average Risk Appetite. While the Greatest Fear and Spread numbers didn’t move much in July, it’s clear that average risk appetite is slowly creeping upwards again after hitting all-time lows at the end of June. This is exactly what we expect to see — as the market goes higher, investors are willing to assume more risk in return for more rewards. The DALBAR research & anecdotal evidence both point towards this phenomonen, where we see investors piling into the market at tops, and getting out at the bottom. Right now we have average risk appetite a 2.25, just higher than last week’s reading of 2.13.
Chart 4: Risk Appetite Bell Curve. This chart uses a bell curve to break out the percentage of respondents at each risk appetite level. Right now the bell curve is biased to the low-risk side, as it has been for the few months. What we see in the bell curve is more evidence that clients are afraid of losing money in the market. Our solitary 5 from last week seems to have disappeared, as a grand total of zero respondents are looking to “Take Risk” in this market.
Chart 5: Risk Appetite Bell Curve by Group. The next three charts use cross-sectional data. This chart plots the reported client risk appetite separately for the fear of downdraft and for the fear of missing upturn groups. We would expect that the fear of downdraft group would have a lower risk appetite than the fear of missing upturn group and that is what we see here.
Once again, we are seeing the missing upturn group swing big towards more risk, based on the market move. In past surveys, we’ve noticed that the upturn group’s risk appetite swings much more volatilely than the downturn group. However, with this few respondents, it’s hard to tell if the volatility is a function of the group as a whole, or the size of the testing sample. For example, we only had nine respondents in the upturn group, so just one wayward click can significantly skew the balance. However, we’ve seen the volatility present itself in surveys with a much higher response rate than this round’s, so we do believe there is something to be said about the volatility of the upturn’s group risk appetite.
Chart 6: Average Risk Appetite by Group. A plot of the average risk appetite score by group is shown in this chart. The downdraft group clocked in at 2.16, while the upturn group scored an average of 3.22. Theoretically, this is what we would expect to see, with the fearful clients wanting less risk than clients worried about missing opportunities.
Once again, the upturn group exhibits a more volatile average appetite than the downdraft group, with another 50 basis point swing versus the downdraft group’s 9 basis point move.
Chart 7: Risk Appetite Spread. This is a spread chart constructed from the data in Chart 6, where the average risk appetite of the downdraft group is subtracted from the average risk appetite of the missing upturn group. The spread is currently 1.06. The jump in the spread can be directly attributed to the swing in the upturn group’s risk appetite.
The market has continued to rally off the lows set in early July, but client sentiment is clearly not following suit. After a +7% correction in the S&P 500, client fear is still dominating broad market sentiment. This round of survey also pointed towards the volatile risk appetite of the upturn group; a larger data-set and more inputs will be needed to determine if the phenomenon is statistically valid, or a function of the few number of respondents in that category.
No one can predict the future, as we all know, so instead of prognosticating, we will sit back and enjoy the ride. A rigorously tested, systematic investment process provides a great deal of comfort for clients during these types of fearful, highly uncertain market environments. Until next time, good trading and thank you for participating!
