Our latest sentiment survey was open from 10/8/10 to 10/15/10. We had nearly the same response rate as last survey, with 93 readers participating. 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. After a few weeks of solid rallying, the market inched slightly higher for this round of survey, up about 1.5% using the survey data points. As expected, client fear levels ticked slightly lower, down to 84% from 86%. Again, we have a roughly 2% market move which correlates almost exactly with the lower client fear levels. The opposite is true of the fear of missing an upturn group, with 16% up from last survey’s reading of 14%. The question here is whether it will take a 40% move from here to get client fear levels at the 50/50 mark.
Chart 2. Greatest Fear Spread. Another way to look at this data is to examine the spread between the two groups. The spread remains skewed towards fear of losing money this round. Again, we see the spread moving towards parity as the market rallies, and the extreme fear levels abate.
Question 2. Based on their behavior, how would you rate your clients’ current appetite for risk?
Chart 3: Average Risk Appetite. After breaking out of the tight summer range, risk appetite crept backwards a few basis points to 2.35, down from 2.40. This reading is so close to last survey’s, we would consider it a flat reading. Keeping in mind that the market was up just over 1% from survey to survey, this round’s number fits nicely with our expectations.
Chart 4: Risk Appetite Bell Curve. This chart uses a bell curve to break out the percentage of respondents at each risk appetite level. Even with the modest rally and the shift towards more risk, clients are definitely not taking many chances in this market. With this indicator, we would expect the bell curve to shift towards more risk if the market continues to rally into the fall. This round, we had a grand total of zero respondents with a risk tolerance of 5 (Take Risk).
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. Again, zero 5′s out of all our respondents.
Chart 6: Average Risk Appetite by Group. A plot of the average risk appetite score by group is shown in this chart. Here we see that the average risk appetite for the fear of losing money group is significantly lower than the risk appetite for the fear of missing the rally group — perfect. Interestingly, this round the upturn group’s risk appetite actually dropped as the market rallied. Have we stumbled upon a new contrarian indicator? We’ve noticed before that the upturn’s group risk appetite is significantly more volatile than the downturn’s group, and this is what we see here again. This round, the upturn group’s risk appetite was 2.8 and the downturn group’s risk appetite was 2.3.
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 dropped by a fairly signifcant margin this round, moving from .78 to .53. This move can be entirely attributed to the upturn’s group lower risk appetite. We’ve noted before that the volatility of the spread is linked directly with the upturn group’s volatile risk tolerance.
This round, we saw a muted market move coupled with a muted client sentiment move. The market rallied modestly, and client fear levels fell by about as much. Again, we are seeing short-term market performance closely tied to long-term investor sentiment, which usually leads to emotional decisions based on relatively irrelevant market performance. The upturn group’s risk appetite actually fell this week, despite the small market rally. Contrarian indicator, anyone? Only time will tell!
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!
