Our latest sentiment survey was open from 11/5/10 to 11/12/10. We had a few more respondents than last survey, with 107 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. From survey to survey, the market rallied over 3%, and client fear levels dropped in kind. Only 71% of clients were afraid of losing money in the market, versus last survey’s reading of 81%. On the flip side, 29% of clients are now afraid of actually missing out on the rally. In late August, 94% of clients were afraid of losing money in the market. It took a 15% market rally to move fear levels to their current reading at 71%.
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, but significantly closer to par. Right now the spread is sitting at 42%, the furthest towards 0% we’ve seen since April of 2010. We would consider this recent move a significant technical breakout.
Question 2. Based on their behavior, how would you rate your clients’ current appetite for risk?
Chart 3: Average Risk Appetite. Risk appetite levels continued higher in their breakout, but not to the same degree as client fear levels. This survey round, risk appetite came in 2.72, up just a little over last survey’s 2.62. Considering that client fear levels fell by such a large degree, it seems like this move is a bit more muted than we’d expect. Average risk appetite is still around its 6-month highs.
Chart 4: Risk Appetite Bell Curve. This chart uses a bell curve to break out the percentage of respondents at each risk appetite level. This week we saw a continuation from last survey’s shift to more risk. We had a smattering of 5′s this round, whereas in the past few months we were lucky to see even one.
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. This chart highlights one of the more nuanced stories of this round of surveys — that average risk appetite has not moved as strongly as client fear levels. In a rally market, we’d expect to see shifts in fear levels to move lower, and risk appetites to move higher. And while this did happen, the fear of missing an upturn group dropped the ball. The upturn group’s risk appetite actually fell this round, to 3.1 from 3.2, possibly suggesting concern that the rally is near the end. The downturn group performed as expected, as their average risk appetite was slightly higher.
We’ve noted before that the upturn group has a much more volatile risk appetite, and this is again what we are seeing here. Could this be a divergence pattern?
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 this week fell by around .10 points, which can be attributed to the upturn group’s falling risk appetite.
There are two big stories in this client sentiment survey — the significant drop in client fear levels, and the muted move in risk appetite. Client fear levels dropped by around 10% from survey to survey, fueled by a market rally that started in August and is now up around 15%. If the rally can manage to sustain itself, it’s likely that client fear levels will continue to drop. Maybe one day, we’ll even see client fear levels at the exact opposite end of the range, below 10%. On the other hand, we would expect risk appetite to continue to rise in-line with the market. This week, we saw the upturn group’s average actually move lower, which may be a divergence pattern (we would expect the risk appetite to move higher with the market, versus diverging from the expected pattern-but that dataset is so young that we may just not yet know what to look for or how to interpret it).
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 
