Our latest sentiment survey was open from 9/10/10 to 9/17/10. We saw a sizeable drop in the response rate, with only 116 readers participating. TSK TSK! 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. The 4% rally that held up from survey to survey had a big impact on client fear levels. 89% of clients were fearful of a downdraft, down from last survey’s reading of 94%. On the flip side, we saw a nice bounce in the missed opportunity group, which moved from only 6% of the respondents to around 11%. The moves don’t represent a seismic shift in broad investor sentiment — they DO, however, show that client sentiment is often directly tied to recent performance. In this case, a 4% move in the market represented a 5% move in client sentiment. For financial health reasons, long-term investor sentiment should probably NOT be tied that closely to short-term market performance.
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. As with the general numbers, the spread tightened a bit to represent the market move, from last week’s reading of 89% to this week’s reading of 77%.
Question 2. Based on their behavior, how would you rate your clients’ current appetite for risk?
Chart 3: Average Risk Appetite. Average risk bounced up to the highest point we’ve seen since the middle of June. The average risk number has been churning around in a tight range since the beginning of summer, and with this move up, the indicator is at the top of its range. Like the market, it’s anyone’s guess as to whether this number will stay range-bound or find the gumption to make a move one way or the other.
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. This week we had zero respondents whose clients would be considered a 5, which is “Take Risk.” With this indicator, we would expect the bell curve to shift towards more risk if the market continues to rally into the fall.
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.
Chart 6: Average Risk Appetite by Group. A plot of the average risk appetite score by group is shown in this chart. These readings come exactly into line with what we’ve noticed before. The downturn group’s risk bumped up about 20 basis points to 2.21, and the upturn group’s moved by about the same amount to 2.87. Usually we’ve noticed that the upturn group’s average appetite moves with much more volatility relative to the downturn group. This week, we saw that effect mitigated a bit, as they both moved by around the same amount.
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 .66, down just a notch from last week’s .67. Normally with a market move, we’ll see the upturn group have a much bigger swing than the downdraft group. Not so with the numbers this week.
This survey’s responses go a long way in highlighting just how sensitive investor sentiment is to recent market performance. We all know that we *should* be making long-term investment decisions based on a long-term time horizon. However, these numbers show the true story — investor sentiment tends to be more correlated with very short-term market performance. This is the exact opposite of what should happen! How many clients are making long-term decisions based on a 5% market move over 2 weeks (in either direction)? That kind of behavior is just plain bad for long-term performance. It’s your job as an advisor to mitigate the effects of the emotional rollercoaster. Good luck!
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!
Posted by JP Lee 
