Client Sentiment Survey Results - 11/9/12

November 20, 2012

Our latest sentiment survey was open from 11/9/12 to 11/16/12. The Dorsey, Wright Polo Shirt Raffle continues to drive advisor participation, and we greatly appreciate your support! This round, we had 69 advisors participate in the survey. 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 fairly comfortable about the statistical validity of our sample. Some statistical uncertainty this round comes from the fact that we only had four investors say that thier clients are more afraid of missing a stock upturn than being caught in a downdraft. 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?

greatestfear 1 Client Sentiment Survey Results 11/9/12

Chart 1: Greatest Fear. From survey to survey, the S&P 500 fell just over -2%, and all of our sentiment indicators responded as expected. The fear of downdraft group crept up to 90%, up from 86%. The fear of missing opportunity group fell from 14% to 10%.

fearspread 3 Client Sentiment Survey Results 11/9/12

Chart 2: Greatest Fear Spread. Another way to look at this data is to examine the spread between the two groups. The spread continued to rise, up to 80% from 71%.

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

avgriskapp 48 Client Sentiment Survey Results 11/9/12

Chart 3: Average Risk Appetite. Average risk appetite fell for the second straight week, dropping from 2.52 to 2.42.

riskappbellcurve 36 Client Sentiment Survey Results 11/9/12

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 round, over 90% of all respondents wanted a risk appetite of 3 or less.

bellcurvegroup 12 Client Sentiment Survey Results 11/9/12

Chart 5: Risk appetite Bell Curve by Group. The next three charts use cross-sectional data. The chat plots the reported client risk appetite separately for the fear of downdraft and for the fear of missing upturn groups. We can see the upturn group wants more risk, while the fear of downturn group is looking for less risk.

avggrouprisk Client Sentiment Survey Results 11/9/12

Chart 6: Average Risk Appetite by Group. This round, the upturn group’s risk appetite grew after an uncharacteristic low last survey. The downturn group’s average fell with the market.

riskappspreadd Client Sentiment Survey Results 11/9/12

Chart 7: Risk Appetite Spread. This is a 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 continues to trend within its set range.

The S&P 500 fell by -2% from survey to survey, and our sentiment indicators responded correctly. The overall fear number grew to 90%, meaning 90% of all clients are more worried about losing money in the market versus missing a market rally. The overall risk appetite also fell this round, in line with the 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.

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More Than Just Information Required

November 20, 2012

Ramit Sethi tweets:

Likewise, there is no shortage of investors (with all the information in the world at their fingertips) who continue to engage in behavior that greatly impairs their investment returns. For your entertainment, here is just one example.

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The Disposition Effect

November 15, 2012

“Everyone” knows that you are supposed to cut your losses and let your winners run—except maybe actual investors. Real-life investors do the opposite, something that behavioral finance types call the “disposition effect.” Aswath Damodaran has a nice summary of the disposition effect on his blog, Musings on Markets.

In particular, there is significant evidence that investors sell winners too early and hold on to losing stocks much too long, using a mixture of rationalization and denial to to justify doing so. Shefrin and Statman coined this the “disposition effect” and Terrence O’Dean looked at the trading records of 10,000 investors in the 1980s to conclude that this irrationality cost them, on average, about 4.4% in annual returns. Behavioral economists attribute the disposition effect to a variety of factors including over confidence (that your original analysis was right and the market is wrong), mental accounting (a paper loss is less painful than a realized loss) and lack of self control (where you abandon rules that you set for yourself).

Whatever the presumed psychological attribution of the disposition effect, 440 basis points of return per year is a lot!

Mr. Damodaran explores a few possible solutions to eliminate the disposition effect. They boil down to this:

  • Regular evaluation of your portfolio
  • A rules-based, automated way to make portfolio decisions

This is very good advice indeed! Although we are not quants in a traditional sense, we use a systematic process for all of our investment products. It requires us to do regular portfolio evaluations and adhere to a rules-based method for making portfolio buy-and-sell decisions. That’s not to say that every decision will be correct—just that we’re not letting irrational psychological factors dictate our investment behavior. If we can recapture some of that 4.4% annual return that average investors give up, it will be a pretty good trade-off.

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Quote of the Week

November 14, 2012

Nervous energy is a great destroyer of wealth.—-Fayez Sarofim

This quote was embedded in an article written by Jim Goff, the research director at Janus. Along with making the case for equities, he talks about how important it is to have a reasonable allocation that you can stick with—and then to leave it alone.

Mr. Goff talks about the way in which many investors undermine their returns:

The average investor is far from contrarian. I remember vividly when a strategist from a top-tier investment firm in the mid-1990’s told me that while the S&P 500 had grown at 13% per year over the prior 10 years, the realized equity returns of his firm’s retail client base, on average, had compounded at only 5% per year. The S&P would have turned $100,000 into $339,000 during that period, but their average investor ended with $163,000.

Often this is caused by jumping in and out of an asset class, rather than by making tactical adjustments within the asset class. There’s nothing wrong with tactical asset allocation as long as it’s done systematically. Even a lousy version of strategic asset allocation—carried out effectively—will probably beat what most investors are doing! Either way, undisciplined fiddling often ruins investment results. Mr. Sarofim’s quote is something to take to heart.

There are a couple of points relevant to portfolio management.

  1. Think about a reasonable asset allocation for your situation, one you can stick with.
  2. Have a systematic process for making portfolio adjustments, not one that is undisciplined and responsive to the news environment.

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Dorsey Wright Client Sentiment Survey - 11/9/12

November 9, 2012

Here we have the next round of the Dorsey, Wright Sentiment Survey, the first third-party sentiment poll. Participate to learn more about our Dorsey, Wright Polo Shirt raffle! Just follow the instructions after taking the poll, and we’ll enter you in the contest. Thanks to all our participants from last round.

As you know, when individuals self-report, they are always taller and more beautiful than when outside observers report their perceptions! Instead of asking individual investors to self-report whether they are bullish or bearish, we’d like financial advisors to weigh in and report on the actual behavior of clients. It’s two simple questions and will take no more than 20 seconds of your time. We’ll construct indicators from the data and report the results regularly on our blog–but we need your help to get a large statistical sample!

Click here to take Dorsey, Wright’s Client Sentiment Survey.

Contribute to the greater good! It’s painless, we promise.

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Fund Flows

November 8, 2012

The Investment Company Institute is the national association of U.S. investment companies, including mutual funds, closed-end funds, exchange-traded funds (ETFs), and unit investment trusts (UITs). Flow estimates are derived from data collected covering more than 95 percent of industry assets and are adjusted to represent industry totals.

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Dorsey Wright Client Sentiment Survey Results - 10/26/12

November 6, 2012

Our latest sentiment survey was open from 10/26/12 to 11/2/12. The Dorsey, Wright Polo Shirt Raffle continues to drive advisor participation, and we greatly appreciate your support! This round, we had 70 advisors participate in the survey. 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 fairly comfortable about the statistical validity of our sample. Some statistical uncertainty this round comes from the fact that we only had four investors say that thier clients are more afraid of missing a stock upturn than being caught in a downdraft. 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?

greatestfear Dorsey Wright Client Sentiment Survey Results 10/26/12

Chart 1: Greatest Fear. From survey to survey, the S&P 500 fell by around -1%, and all of our indicators responded as expected. The fear of downdraft group rose slightly from 84% to 86%. The fear of missing opportunity group fell from 16% to 14%.

fearspread 2 Dorsey Wright Client Sentiment Survey Results 10/26/12

Chart 2: Greatest Fear Spread. Another way to look at this data is to examine the spread between the two groups. The spread rose slightly from 69% to 71%.

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

avgriskapp 47 Dorsey Wright Client Sentiment Survey Results 10/26/12

Chart 3: Average Risk Appetite. Average risk appetite took a big hit this week, falling from 2.71 to 2.52. It looks like this recent market downturn is starting to put the squeeze on investor sentiment.

bellcurve 9 Dorsey Wright Client Sentiment Survey Results 10/26/12

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 round, over 90% of all respondents wanted a risk appetite of 3 or less.

riskappbellcurve 35 Dorsey Wright Client Sentiment Survey Results 10/26/12

Chart 5: Risk appetite Bell Curve by Group. The next three charts use cross-sectional data. The chat plots the reported client risk appetite separately for the fear of downdraft and for the fear of missing upturn groups. This chart sorts out as expected, with the downturn group wanting less risk and the upturn group looking to add risk.

avgriskgroup Dorsey Wright Client Sentiment Survey Results 10/26/12

Chart 6: Average Risk Appetite by Group. The average risk appetite of both groups fell this round by a large degree, in line with the market.

riskappspread 48 Dorsey Wright Client Sentiment Survey Results 10/26/12

Chart 7: Risk Appetite Spread. This is a 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 now at the lower end of its normal range.

The S&P 500 fell around -1% from survey to survey, and the results were what we’d expect to see. The overall fear number rose as the market fell. Also, the overall risk appetite average also fell with the 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.

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CNBC: Public Enemy #1?

November 1, 2012

A recent article at AdvisorOne suggests that CNBC is detrimental to the well-being of your clients. In truth, it didn’t really single out CNBC. It was applicable to any steady diet of financial news. Here’s what the article had to say about financial news and client stress:

Clients get stressed by things you wouldn’t predict. This is a classic example, uncovered at the Kansas State University (KSU) Financial Planning Research Center by Dr. Sonya Britt of KSU and Dr. John Grable, now at the University of Georgia, in their recent paper “Financial News and Client Stress.” They found that contrary to what you might think, client stress goes up when watching financial news, and hearing that the market went up causes stress levels to rise even higher. “Specifically, 67% of people watching four minutes of CNBC, Bloomberg, Fox Business News and CNN showed increased stress, while 75% of those who watched a positive-only news video exhibited an increase in stress,” they wrote.

Why? “Financial news was found to increase stress levels, particularly among men,” wrote Grable and Britt. Surprisingly, positive financial news, like reports of bullishness in the stock market, created the highest levels of stress, they found, suggesting that positive financial news may trigger regret among some people. The authors referred to previous studies of regret that found “people tend to feel most remorseful when they look back at a situation and realize that they failed to take action.” The authors’ conclusion: Financial advisors should think twice about having office TVs tuned to financial channels.

Surprising, isn’t it, to find out that clients were stressed even when the market was going up? The ups and downs of the market appear to elicit client’s concerns about their financial decisions. Anything that undermines their confidence is probably not a positive. In fact, one of the important things advisors can do is help clients manage their investment behavior. Financial news appears to work at cross-purposes to that. (Other things do too; the full article has a host of useful thoughts on what stresses clients and how to reduce client stress.)

The relationship between high levels of stress and poor decision-making is well-known to psychologists, researchers and sports fans around the world. “Our brains operate on different levels, depending on circumstances,” Britt told me in an interview. “Under high levels of stress, our intellectual decision-making functions shut down, and our emotional flight or fight response kicks in.” Added Grable: “People will adapt to low levels of stress differently, but overwhelming stress results in predictable behavior. When we are stressed, our brains cannot move to make intellectual decisions.”

If we want to help our clients stay calm and stick with their plan, maybe we should ask about their family, their pets, and their hobbies in a relaxed setting rather than inundating them with market data.

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Human Nature and Markets

October 30, 2012

Does human behavior evolve or is human nature relatively unchanging? A recent Wall Street Journal article by Jason Zweig made the case for human nature as relatively stable when it discussed the results of a fascinating study. Here’s the back story:

A fascinating new research paper analyzes how individual investors built stock portfolios soon after building portfolios first became possible: from 1690 to 1730.

The researchers, led by the distinguished financial historian Larry Neal of the University of Illinois, painstakingly replicated all the holdings and trades in the Bank of England, the East India Co. and the United East India Co., the Royal African Co., the Hudson’s Bay Co., the Million Bank and the South Sea Co. These were the dominant companies at the birth of the British capital markets three centuries ago. The share registries survive, so the scholars were able to match virtually every investment with the person who held it – encompassing 5,813 investors during the 1690s and 23,723 by the end of the period.

As a result, the way portfolios were constructed around 1700 can be compared to the way investors construct portfolios now. Mr. Zweig writes:

Three centuries ago, investors:

  • underdiversified, with 86% of them owning shares in only a single stock;
  • chased performance, with rising prices leading to higher trading volume;
  • underperformed the market as a whole, earning lower returns and incurring higher risk.

There’s little evidence of change in human nature now.

Investors today:

He concludes that:

The research findings on investors in the early days of the British stock market should remind us all that human nature is the same today as it was in the days of clay pipes, quill pens and horse-drawn carriages.

The investing crowd is as foolish now as it was then – or perhaps more so, considering that foolishness can spread faster over Twitter and smartphones than it could by foot through cobblestone streets.

In order to be a superior investor, you have to combat the crazy ideas of those around you and, above all, fight the hobgoblins in your own head. That was true in 1720. It is at least as true in 2012 as it was then.

Human nature is not an easy opponent for investors. We can’t run away from it because it is part of who we are. As a result, however, return factors that are based on human nature, like relative strength and value, are unlikely to change. That knowledge, at least, is somewhat comforting.

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Dorsey Wright Client Sentiment Survey - 10/26/12

October 26, 2012

Here we have the next round of the Dorsey, Wright Sentiment Survey, the first third-party sentiment poll. Participate to learn more about our Dorsey, Wright Polo Shirt raffle! Just follow the instructions after taking the poll, and we’ll enter you in the contest. Thanks to all our participants from last round.

As you know, when individuals self-report, they are always taller and more beautiful than when outside observers report their perceptions! Instead of asking individual investors to self-report whether they are bullish or bearish, we’d like financial advisors to weigh in and report on the actual behavior of clients. It’s two simple questions and will take no more than 20 seconds of your time. We’ll construct indicators from the data and report the results regularly on our blog–but we need your help to get a large statistical sample!

Click here to take Dorsey, Wright’s Client Sentiment Survey.

Contribute to the greater good! It’s painless, we promise.

Leave a Comment » | Investor Behavior, Markets, Sentiment | Permalink

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Dorsey Wright Client Sentiment Survey Results - 10/12/12

October 22, 2012

Our latest sentiment survey was open from 10/12/12 to 10/19/12. The Dorsey, Wright Polo Shirt Raffle continues to drive advisor participation, and we greatly appreciate your support! This round, we had 90 advisors participate in the survey. 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 fairly comfortable about the statistical validity of our sample. Some statistical uncertainty this round comes from the fact that we only had four investors say that thier clients are more afraid of missing a stock upturn than being caught in a downdraft. 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?

greatestfear 59 Dorsey Wright Client Sentiment Survey Results 10/12/12

Chart 1: Greatest Fear. From survey to survey, the S&P 500 fell by around -1%, and some of our indicators responded as expected. The fear of downdraft grop fell slightly with a falling market, from 86% to 85%, which is the opposite of what we’d expect to see in a down market. The fear of missing opportunity group rose from 14% to 16%.

fearspreaad Dorsey Wright Client Sentiment Survey Results 10/12/12

Chart 2: Greatest Fear Spread. Another way to look at this data is to examine the spread between the two groups. The spread fell from 73% to 69%.

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

avgriskapp 46 Dorsey Wright Client Sentiment Survey Results 10/12/12

Chart 3: Average Risk Appetite. Average risk appetite fell with the market, which is what we’d expect to see. Average risk appetite fell from 2.89 to 2.71.

riskappbellcurve 34 Dorsey Wright Client Sentiment Survey Results 10/12/12

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 round, over 80% of all respondents wanted a risk appetite of either 2 or 3.

riskappbellcurvegroup 17 Dorsey Wright Client Sentiment Survey Results 10/12/12

Chart 5: Risk appetite Bell Curve by Group. The next three charts use cross-sectional data. The chat plots the reported client risk appetite separately for the fear of downdraft and for the fear of missing upturn groups. This chart sorts out as expected, with the downturn group wanting less risk and the upturn group looking to add risk.

riskappbygroup 2 Dorsey Wright Client Sentiment Survey Results 10/12/12

Chart 6: Average Risk Appetite by Group. The average risk appetite of both groups fell this round, in line with the market.

riskappspread 47 Dorsey Wright Client Sentiment Survey Results 10/12/12

Chart 7: Risk Appetite Spread. This is a 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 now back in its normal range.

The S&P 500 fell around -1% from survey to survey, and the results were a mixed bag. The overall fear number did the opposite of what we’d expect, with LESS people worried about losing money despite a falling market. However, our trusty risk appetite indicator fell along with the market, with people wanting less risk as stocks dropped.

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.

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Net Wealth Shock and Portfolio Diversification

October 19, 2012

Professor Amir Sufi (University of Chicago Booth School of Business) is an interesting researcher. He recently tweeted a picture of what he called “net wealth shock” to show how the recession had affected various families. It’s reproduced below, but in effect, it shows that low and median net worth families have had a large negative impact from the recession while high net worth families have been impacted much less. I think portfolio diversification has everything to do with it.

netwealthshock Net Wealth Shock and Portfolio Diversification

The Effect of Buying One Stock on Margin

Source: Amir Sufi (click on image to enlarge)

For clues to why this happened, consider an earlier paper that Dr. Sufi co-wrote on household balance sheets. I’ve linked to the entire paper here (you should read it for insight into very clever experimental design), but here’s the front end of the abstract:

The large accumulation of household debt prior to the recession in combination with the decline in house prices has been the primary explanation for the onset, severity, and length of the subsequent consumption collapse.

Later in the paper, he reiterates that it is the combination of these two things that is deadly.

The household balance sheet shock in high leverage counties came from two sources: high ex ante debt levels and a large decline in house prices. One natural question to ask is: could the decline in house prices alone explain the collapse in consumption in these areas?

Our answer to this question is a definitive no-it was the combination of house price declines and high debt levels that drove the consumption decline.

And he and his co-authors, through clever data analysis, proceed to explain why they believe that to be the case.

Now consider what this is saying from a portfolio management point of view: why was the impact of falling home prices so devastating to low and median net worth households?

The negative impact came primarily from lack of diversification. Low and median net worth households had essentially one stock on margin. I know people don’t think they are buying their house on margin, but the net effect of a home loan—magnifying gains and losses—is the same. When that stock (their house) went south, their net worth went right along with it.

High net worth households were simply better diversified. It’s not that their houses didn’t decline in value also; it’s just that their house was not their only asset. In addition, they were less leveraged.

There are probably a couple of things to take away from this.

  • Diversify broadly. It’s no fun to have everything in one asset when things go wrong, whether it’s your house or Enron stock in your pension plan.
  • Debt kills. Having a single asset that nosedives is bad, but having it on margin is disastrous. There’s no room for error with leverage—and no way to wait things out.

Perhaps high net worth families are more diversified simply because they have greater wealth. Maybe they took the same path as everyone else and just got lucky not to have a recession in the middle of their journey. However, I think it’s also worth contemplating the converse: maybe those families achieved greater wealth because they diversified more broadly and opted to use less leverage.

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Raging Bull Market

October 18, 2012

I saw an article on CNBC that discussed the opinion of Citigroup strategist Tobias Levkovich. Here’s an excerpt of his thinking on a bull market:

Tobias Levkovich, Citigroup’s U.S. strategist, is expecting the market to enter a ‘raging bull’ market next year.

While he continues to stick with his 2013 year-end target on the S&P 500 of 1,615, that would take the index above the prior peak of 1,558 reached in 2007.

Is this valid? I have no idea. However, I am getting pretty sick of reading bearish forecasts, so I like the way Mr. Levkovich thinks!

In truth, things are never usually as bad or as good as people forecast. Given the pervasive gloom surrounding equity markets for the last several years, a bull market is not out of the question. The stock market often does whatever is required to make the most people wrong, and a bull market would certainly catch a lot of investors flat-footed.

 

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Affluent Investors Settle Down

October 17, 2012

According to a Merrill Lynch survey of affluent investors, they are beginning to adapt to the current economic and market situation as the new normal, as opposed to looking at it as a temporary period of high volatility. Perhaps because they’ve now made that psychological leap, affluent investors are beginning to feel that their situation is more stable. From a Penta article:

To prepare for a more volatile environment, this affluent group also is making efforts to control what they can by spending less, paying down debt, and generally “putting their lives in check,” Durkin said. Of the families surveyed, 50% said they’ve taken steps to gain greater control of their finances, like sticking to a budget (32%), making more joint investment decisions with a spouse (29%), and setting tangible goals (28%). One third of respondents said they’re living “more within their means.”

In other words, the affluent are adapting by toggling back their lifestyle and saving more.

Making that psychological shift is critical because it allows a lot of good things to happen. It’s also perhaps a realization that although you can’t control the markets, there is a lot you can control that will impact your eventual net worth—namely, living beneath your means and saving more. Being affluent, in and of itself, won’t build net worth.

Once a client has good habits in place, compounding kicks in and net worth tends to grow more rapidly than clients expect. Clients are usually delighted with this discovery!

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Dorsey Wright Client Sentiment Survey - 10/12/12

October 12, 2012

Here we have the next round of the Dorsey, Wright Sentiment Survey, the first third-party sentiment poll. Participate to learn more about our Dorsey, Wright Polo Shirt raffle! Just follow the instructions after taking the poll, and we’ll enter you in the contest. Thanks to all our participants from last round.

As you know, when individuals self-report, they are always taller and more beautiful than when outside observers report their perceptions! Instead of asking individual investors to self-report whether they are bullish or bearish, we’d like financial advisors to weigh in and report on the actual behavior of clients. It’s two simple questions and will take no more than 20 seconds of your time. We’ll construct indicators from the data and report the results regularly on our blog–but we need your help to get a large statistical sample!

Click here to take Dorsey, Wright’s Client Sentiment Survey.

Contribute to the greater good! It’s painless, we promise.

Leave a Comment » | Investor Behavior, Markets, Sentiment | Permalink

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Retirement Income Karma Boomerang

October 11, 2012

From time to time, I’ve written about karma boomerang: the harder you try to avoid getting nailed, the more likely it is that you’ll get nailed by exactly what you are trying to avoid. This concept came up again in the area of retirement income in an article I saw at AdvisorOne. The article discussed a talk given by Tim Noonan at Russell Investments. The excerpt in question:

In [Noonan's] talk, “Disengagement: Creating the Future You Fear,” he observed that lack of engagement in retirement planning is leading people toward the very financial insecurity they dread. What they need to know, and are not finding out, is simply whether they’ll have enough money for their needs.

I added the bold. This is a challenge for investment professionals. Individuals are not likely on their own to go looking for their retirement number. They are also not likely to go looking for you, the financial professional. They may realize they need help, but are perhaps intimidated to seek it—or fearful of what they might find out if they do investigate.

Retirement income is probably not an area where you want to tempt karma! Retirement income is less secure than ever for many Americans, due to under-funded pension plans, neglected 401k’s, and a faltering Social Security safety net. The only way to secure retirement income for investors is to reach out to them and get them engaged in the process.

Mr. Noonan, among other suggestions, mentioned the following:

  • “Personalization” is tremendously appealing. “Tailoring” may be an even more useful term, since “people don’t mind if the tailor reuses the pattern,” Noonan explained. They may even enjoy feeling part of an elite group.
  • “Tactical investing” is viewed positively. “People know they should be more adaptive, but they aren’t sure what of,” said Noonan. Financial plans should adapt to the outcomes they’re producing, not to hypothetical market forecasts.

Perhaps personalization and tactical investing can be used as hooks to get clients moving. To reach their retirement income goals, they are going to need to save big and invest intelligently, but none of that will happen if they aren’t engaged in the first place.

1 Comment | From the MM, Investor Behavior, Retirement/Saving, Tactical Asset Alloc, Thought Process | Tagged: , , , | Permalink

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Fund Flows

October 11, 2012

The Investment Company Institute is the national association of U.S. investment companies, including mutual funds, closed-end funds, exchange-traded funds (ETFs), and unit investment trusts (UITs). Flow estimates are derived from data collected covering more than 95 percent of industry assets and are adjusted to represent industry totals.

Equity outflows doubled in one week, while taxable bond inflows almost doubled. Lots of money moving around!

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Dorsey Wright Client Sentiment Survey Results 9/28/12

October 9, 2012

Our latest sentiment survey was open from 9/28/12 to 10/5/12. The Dorsey, Wright Polo Shirt Raffle continues to drive advisor participation, and we greatly appreciate your support! This round, we had 45 advisors participate in the survey. 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 fairly comfortable about the statistical validity of our sample. Some statistical uncertainty this round comes from the fact that we only had four investors say that thier clients are more afraid of missing a stock upturn than being caught in a downdraft. 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?

greatestfear 58 Dorsey Wright Client Sentiment Survey Results 9/28/12

Chart 1: Greatest Fear. From survey to survey, the S&P 500 fell around -1.5%, and some of our indicators responded as expected. The fear of downdraft group rose from 81% to 86%, while the upturn group fell from 19% to 14%. This is what we’d expect to see in a falling market.

greatestfearspread 55 Dorsey Wright Client Sentiment Survey Results 9/28/12

Chart 2: Greatest Fear Spread. Another way to look at this data is to examine the spread between the two groups. The spread continued to rise, from 61% to 73%.

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

avgriskapp 45 Dorsey Wright Client Sentiment Survey Results 9/28/12

Chart 3: Average Risk Appetite. Average risk crept higher as the market fell, which is not typical. However, you can see that the overall trend remained positive over the summer as the market moved higher. Average risk appetite fell from 2.89 to 2.81.

riskappbellcurve 33 Dorsey Wright Client Sentiment Survey Results 9/28/12

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 round, over 50% of all respondents requested a risk appetite of 3. There were no 5′s.

riskappbellcurvegroup 16 Dorsey Wright Client Sentiment Survey Results 9/28/12

Chart 5: Risk appetite Bell Curve by Group. The next three charts use cross-sectional data. The chat plots the reported client risk appetite separately for the fear of downdraft and for the fear of missing upturn groups. This chart sorts out as expected, with the downturn group wanting less risk and the upturn group looking to add risk.

avgriskappgroup 32 Dorsey Wright Client Sentiment Survey Results 9/28/12

Chart 6: Average Risk Appetite by Group. The average risk appetite of both groups rose this week despite a falling market.

riskappspread 46 Dorsey Wright Client Sentiment Survey Results 9/28/12

Chart 7: Risk Appetite Spread. This is a 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 now back in its normal range.

The S&P 500 fell around -1.5% from survey to survey, and our indicators held a mixed bag this round. The greatest fear number rose, which we’d expect. On the other hand, we saw the overall risk appetite number tick slightly higher.

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.

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Serenity for Investors

October 9, 2012

Grant me the serenity to accept the things I cannot change, the courage to change the things I can, and the wisdom to know the difference—-Reinhold Niebuhr

Serenity is in short supply in the investment community! Capital Group/American Funds recently posted a fantastic commentary on uncertainty, pointing out that investors are much better off if they focus on what they can control and don’t sweat the other stuff. Here are some excerpts that struck me—but you should really read the whole thing.

Powerless. That’s how a lot of investors feel. In a recent Gallup poll, 57% of investors said they feel they have little or no control over their efforts to build and maintain their retirement savings. What’s causing them to feel so lost? According to 70% of those polled, the most important factor affecting the investment climate is something they can’t control, the federal budget deficit.

On the flip side, among investors with a written financial plan having specific goals or targets, the poll showed 80% of nonretirees and 88% of retirees said their plan gives them the confidence to achieve their financial goals. It seems like some investors have figured out what they can control and what they can’t.

Life for investors would be simpler if there were a handy timetable by which these issues would be resolved in a quick and orderly fashion. But successful investors know they can’t control the outcome of the euro-zone summits or American fiscal debates, much less plug politics into a spreadsheet.

They can, however, review their goals, manage risk, be mindful of valuation and yield and remember that diversification may matter now more than ever. It’s easy to overlook in such a challenging environment, but unsettled times can also offer opportunities for long-term investors. In the midst of uncertainty, there are companies with strong balance sheets, smart management and innovative products that continue to thrive, and whose shares may be attractively valued.

All true! We’ve written before about what an important investment attribute patience is. Maybe in some important way, serenity contributes to patience. It’s hard to be patient when you’re worried about everything, especially things you have no control over! They even include a handy-dandy graphic with suggested responses to all of those things disturbing your serenity.

Serenity AmericanFundsDistributors Serenity for Investors

Source: American Funds Distributors (click on image to enlarge)

At some level, perhaps we are all control freaks. Unfortunately for us, in a relationship with the market, it’s the market that is in control! We can’t control market events, but we can control our responses to those events. Finding healthy ways to manage market anxiety is a primary focus for every successful investor.

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Reaching for Yield

October 5, 2012

More money has been lost reaching for yield than at the point of a gun—Raymond Devoe

According to a recent article in the Wall Street Journal, desperate investors are reaching for yield, this time in the high-yield bond market. The less-polite name for these securities is junk bonds. Why do investors love them so? Well, they pay out fat yields—but, of course, they come with commensurate risks. And there are already warning signs in the market.

So much money has flooded into the junk-bond market from yield-hungry investors that weaker and weaker companies are able to sell bonds [they say]. Credit ratings of many borrowers are lower and debt levels are higher, making defaults more likely. And with yields near record lows, they add, investors aren’t being compensated for that risk.

Also worrying money managers is that some new sales have similar hallmarks to those that preceded the financial crisis in 2008. Petco Animal Supplies Inc. and Emergency Medical Services Corp. recently offered to sell bonds that let them pay interest in the form of more bonds, instead of cash, a common provision before the crisis.

Skeptics note that now weaker companies are the ones borrowing. The portion of new bonds sold by high-yield companies with credit ratings of double-B and above shrank last month to 20% from an average of 30% for the year.

After three years of financial improvement, high-yield companies are now weakening by some measures. Total debt for all high-yield companies rose 7.2% in the 12 months through June—the largest rise since 2008—while cash on their balance sheet fell 2.3%, according to research by Morgan Stanley. S&P downgraded 45% more companies than it upgraded in 2012, reversing the trend of 2010 and 2011. And companies are offering investors fewer protections than usual.

Now, this is just supply and demand at work. Investors want yield and companies are happy to oblige them, especially if they are willing to buy really junky securities.

The problem is that, from time to time, investors forget that investing is about total return, not just yield. An 8% yield with a 20% capital loss still puts you in the hole. Likewise, buying a stock that appreciates 20% but that does not pay a dividend still puts you way ahead of the game. When you go to the store to buy groceries, the store owner does not care if the money comes from labor, dividends, interest, or capital gains.

Money is money, however you make it. You’re probably better off—and safer—with a healthy total return from a well-diversified portfolio than you are reaching for yield.

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Fund Flows

October 4, 2012

The Investment Company Institute is the national association of U.S. investment companies, including mutual funds, closed-end funds, exchange-traded funds (ETFs), and unit investment trusts (UITs). Flow estimates are derived from data collected covering more than 95 percent of industry assets and are adjusted to represent industry totals.

When will the bloodbath end?

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Investors’ Biggest Mistake: Excessive Caution

October 3, 2012

Investors are interesting creatures. Studies of fund flows show that investors tend to buy near peaks and to sell near low points. This year investors have been piling into bond funds. Yet when the Wall Street Journal ran an online poll to ask investors what their biggest investing mistake had been, it was this: too much caution. And it wasn’t even close—excessive caution won out by a large margin. (Of course, buying near the peak had a decent second-place showing.) Here’s the accompanying graphic:

Source: Wall Street Journal (click on image to enlarge)

I find it fascinating that investors in aggregate report that caution has been their biggest mistake, all the while piling into bond funds over the past few years as the equity market had spectacular returns!

Investing for comfort is generally a poor idea. Markets are inherently uncomfortable—if you’re comfortable, in other words, you’re probably not doing it right.

Being too cautious is an insidious problem. Individual investors can end up with sub-par returns if they don’t expose their portfolio to growth assets. Growth assets tend not to be very comfortable. While volatility levels can be reduced somewhat by good diversification, it’s still the uncomfortable assets that will generate much of your return over time. When you put together an asset allocation, it should have as much exposure to growth as possible, given the constraints of the individual client.

Why, then, is caution so prized? I suspect it is because people wish to have positive self-regard and because mistakes reduce that self-regard for many people. They err on the side of caution because they are trying to avoid mistakes. While this may be psychologically wonderful, it is counterproductive in financial markets. In fact, research shows that you are actually more likely to make a mistake through excessive caution than from being overly aggressive. Investors, judging from the poll results, seem to understand this in retrospect—although maybe not prospectively.

If you invest, you are going to make mistakes. There is no way to sugarcoat it. Not everything is going to work out. We think the best way to avoid excessive caution is to adopt a systematic investment process. If you have a systematic way to determine what to buy, when to buy it, and when to sell it, you may be less likely to pull your punches.

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Quote of the Week

October 1, 2012

[NYC] cabbies drive in much the way that people typically manage portfolios – alternately “putting pedal to the medal” and slamming on the brakes.—-Bob Seawright, CIO Madison Avenue Securities

I laughed when I read this, thinking back to a NYC cab ride to JFK to catch an ill-fated flight back to Los Angeles. One of our portfolio managers, John Lewis, was in the cab with me and I thought he was either going to yak out his window or club the cabbie with his briefcase. Let’s just say that the cabdriver made full use of both the accelerator and brake pedals.

Is it any wonder investors have a tough time making money when they can’t discipline themselves to coast occasionally?

It’s important to make portfolio changes when necessary—and equally important to know when to leave things alone. As investment professionals, we spend our careers trying to learn the difference.

taxi cab Quote of the Week

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Dorsey Wright Client Sentiment Survey - 9/28/12

September 28, 2012

Here we have the next round of the Dorsey, Wright Sentiment Survey, the first third-party sentiment poll. Participate to learn more about our Dorsey, Wright Polo Shirt raffle! Just follow the instructions after taking the poll, and we’ll enter you in the contest. Thanks to all our participants from last round.

As you know, when individuals self-report, they are always taller and more beautiful than when outside observers report their perceptions! Instead of asking individual investors to self-report whether they are bullish or bearish, we’d like financial advisors to weigh in and report on the actual behavior of clients. It’s two simple questions and will take no more than 20 seconds of your time. We’ll construct indicators from the data and report the results regularly on our blog–but we need your help to get a large statistical sample!

Click here to take Dorsey, Wright’s Client Sentiment Survey.

Contribute to the greater good! It’s painless, we promise.

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Danger: Pundits Ahead

September 27, 2012

The danger of listening to the forecasts of pundits is obvious. For one thing, pundits are just as likely to get it wrong as anyone else. The Big Picture carried a list of bullish forecasts from the beginning of the internet bubble that is illustrative. (The original source was apparently Paul Farrell at Marketwatch.)

March 1999: Harry S. Dent, author of “The Roaring 2000s.” “There has been a paradigm shift.” The New Economy arrived, this time really is different.

October 1999: James Glassman, author, “Dow 36,000.” “What is dangerous is for Americans not to be in the market. We’re going to reach a point where stocks are correctly priced … it’s not a bubble … The stock market is undervalued.”

August 1999: Charles Kadlec, author, “Dow 100,000.” “The DJIA will reach 100,000 in 2020 after “two decades of above-average economic growth with price stability.”

December 1999: Joseph Battipaglia, market analyst. “Some fear a burst Internet bubble, but our analysis shows that Internet companies … carry expected long-term growth rates twice other rapidly growing segments within tech.”

December 1999: Larry Wachtel, Prudential. “Most of these stocks are reasonably priced. There’s no reason for them to correct violently in the year 2000.” Nasdaq lost over 50%.

December 1999: Ralph Acampora, Prudential Securities. “I’m not saying this is a straight line up. … I’m saying any kind of declines, buy them!”

February 2000: Larry Kudlow, CNBC host. “This correction will run its course until the middle of the year. Then things will pick up again, because not even Greenspan can stop the Internet economy.” He’s still hosting his own cable show.

April 2000: Myron Kandel, CNN. “The bottom line is in, before the end of the year, the Nasdaq and Dow will be at new record highs.”

September 2000: Jim Cramer, host of “Mad Money.” Sun Microsystems “has the best near-term outlook of any company I know.” It fell from $60 to below $3 in two years.

November 2000: Louis Rukeyser on CNN. “Over the next year or two the market will be higher, and I know over the next five to 10 years it will be higher.”

December 2000: Jeffrey Applegate, Lehman strategist. “The bulk of the correction is behind us, so now is the time to be offensive, not defensive.” Another sucker’s rally.

December 2000: Alan Greenspan. “The three- to five-year earnings projections of more than a thousand analysts … have generally held firm. Such expectations, should they persist, bode well for continued capital deepening and sustained growth.”

January 2001: Suze Orman, financial guru. “The QQQ, they’re a buy. They may go down, but if you dollar-cost average, where you put money every single month into them, I think, in the long run, it’s the way to play the Nasdaq.” The QQQ fell 60% further.

March 2001: Maria Bartiromo, CNBC anchor. “The individual out there is actually not throwing money at things that they do not understand, and is actually using the news and using the information out there to make smart decisions.”

April 2001: Abby Joseph Cohen, Goldman Sachs. “The time to be nervous was a year ago. The S&P was overvalued, it’s now undervalued.” Markets fell 18 more months.

August 2001: Lou Dobbs, CNN. “Let me make it very clear. I’m a bull, on the market, on the economy. And let me repeat, I am a bull.”

June 2002: Larry Kudlow, CNBC host. “The shock therapy of a decisive war will elevate the stock market by a couple thousand points.” He also predicted the Dow would hit 35,000 by 2010.

Note: The Dow didn’t bottom until October 2002 at 7,286, down from 11,722.

These examples are particularly egregious because they happened at a market turning point, but the danger from listening to pundits is continuous. You can always find pundits spouting their opinions on CNBC or other media. To the extent that they influence you into not executing your thoughtful, systematic investment plan, pundits are a problem.

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