Systematic Relative Strength

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 five 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 S&P 500 fell by around -0.7%. Although the market move wasn’t that dramatic, there was plenty of volatility and a few down days in a row in the days leading up to when we opened the survey. With that in mind, the greatest fear numbers spiked right back up after hitting all-time survey lows — 79% of clients were more afraid of losing money, up from 66%. On the other side, 21% of clients were more afraid of missing a rally, down from 34%. Unfortunately, all it takes is a minor drawdown and some volatility, and clients run for the hills…this is what we expect to see.

Chart 2. Greatest Fear Spread. Another way to look at this data is to examine the spread between the two groups. The spread also shot higher after hitting all-time lows, up to 57% from 32% the survey before.

Question 2. Based on their behavior, how would you rate your clients’ current appetite for risk?

Chart 3: Average Risk Appetite. Average risk appetite managed to click up a hundreth of a point, from 2.97 to 2.98. This represents an interesting reading, as the usually unflappable indicator went against the grain to move higher in the face of a falling market. Also, keep in mind that average risk appetite is still sitting at all-time survey highs!

What does this mean? It could mean that despite the minor correction, more and more clients are unwilling to sit on the sidelines anymore and watch the S&P just go higher and higher. The emotional pain of sitting out a huge rally is taking its toll on sentiment, and clients are becoming unwilling to lower their risk appetite in the face of perceived risk (a minor correction).

Chart 4: Risk Appetite Bell Curve. This chart uses a bell curve to break out the percentage of respondents at each risk appetite level. The most common risk appetite was 3 this round, with just over half of all respondents. We had a large number of 5′s this round, and you can see that the average risk appetite number also matches nicely with this graph (the average is 2.98, and the majority of respondents answered 3).

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’re noticing that more and more of the missed opportunity group is responding 4, whereas in previous surveys we saw mostly 3′s from this group. Also take note of the respondents from the downturn group wanting to add risk (with 4′s and even a 5)…more evidence that even those who are afraid of losing money, are also looking to add risk.

Chart 6: Average Risk Appetite by Group. The average risk appetite by group this survey syncs up with the overall average risk appetite numbers. Both groups are looking to add risk, despite a market correction. The missed opportunity group is now sitting at all-time highs, with a risk appetite of 3.66. We expect both groups’ average to move higher as the market continues to rise.

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 one of the less volatile indicators found in the survey, and continues to trade within a fairly stable range.

This round we saw a minor correction in the S&P 500, and client fear levels jumped as a result. However, the big standout would have to be the average risk appetite indicator (and its corollary), as risk appetite managed to climb even higher despite a market pullback. This points towards an underlying trend of clients wanting to get in the market, with the S&P 500 up around +19% over the past 12 months. Clients may eventually be unable to contain their greed, and may jump head-first into a hot market!

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