Since the bottom of the market at the depth of the financial crisis in early 2009, investors seem to be taking a more cautious view of the markets based on reported investor sentiment. It really hasn't been until this year that the S&P 500 Index has been able to make a sustained push above the market highs of early 2000. In mid to late 2007 the S&P was able to briefly surpass the 2000 highs; however, this was short lived as the financial crisis began to unfold.
An apparent result of the bursting of the technology bubble in early 2000 and the financial crisis in late 2007/2008, is the increased skepticism in which investors view the market. Some of this skepticism can be attributable to "recency bias" given the magnitude of the market's decline during the bursting of the tech bubble and the decline during the financial crisis. For an investor recency bias is when an investor uses recent past experience as the basis for what will happen in the future. The lost decade of the 2000s seems to have extended an investor's look back period to as far as 2000. Investors seem to express this cautious market view in reported sentiment surveys.
One popular sentiment measure is provided by the American Association of Individual Investors (AAII). AAII reports individual investor sentiment in a weekly sentiment survey. Below is a table that displays the maximum and minimum sentiment readings by year going back to the year 2000. The average of the bullish maximum percentage from 2000 through 2008 is 63%. The average of the bullish maximum percentage from 2009 through 2013 has declined to 55%. Does the individual investor view their portfolio as under invested in equities, i.e., waiting for a market pullback? This 2009 through 2013 period is also displayed separately in the table below the full spreadsheet.
A significant outcome resulting from the heightened investor skepticism is the fact the market continues to move higher, i.e., a long "climb the wall of worry" market. The below chart shows the S&P 500 Index price chart since the bottom of the financial crisis in 2009 through the market's close on November 8, 2013. As easily seen on this chart, the S&P has trended higher within a well defend uptrend channel. This move has not been in a straight line; however, it is higher nonetheless. This uptrend has been in place for four and a half years.
Given the lack of euphoria shown by investors, is it possible this market continues to deliver new highs? In the market's favor is the number of strategist and commentators stating the market is due for a correction. I could site a number of other potentially negative factors like, the elevated cyclically adjusted P/E ratio, single digit earnings growth and the presumed low levels of investor cash, just to name a few. Another positive is the fact the market is in a favorable seasonal period. And let's not forget the accommodative Fed. In other words, there seems to be quite a number of reasons the market should correct. The market, however, generally does not correct when the majority thinks it will. More discussion on this can be found in our most recent Investor Letter.
Yes, the market "could" be long in the tooth as they say. At HORAN Capital Advisors, we recently eliminated our small cap exposure in client accounts. For several years, we have allocated a portion (10%-15%) of client investments to alternative investments like absolute return and long short funds. We have not introduced alternative investments into our investment approach as a replacement for equity though. These alternatives are mainly exposure in lieu of some classes of fixed income in an effort to generate returns better than bonds, yet not take the same level of risk as if we had increased our equity allocation. This strategy has worked well for our clients.
In conclusion, sentiment figures tend to be most accurate at their extremes. Is it likely the individual investor has such a cautious view of the equity market because of their investment experience following the tech bubble and financial crisis that they now are viewing the slightest market pullback as a buying opportunity? Because of this, and assuming fundamental data continues to come in "okay", might the market continue to trend higher? We will certainly know in hindsight at some point in the future.
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