It is bullish for the stock market that the average household’s equity allocation has fallen as much as it has.
I refer to an indicator that its creator, the anonymous author of the Philosophical Economics Blogdubbed “The Greatest Predictor of Future Stock Returns”.
The average household’s portfolio allocation to equities is a contrarian indicator, with higher allocations being correlated with lower stock market returns and vice versa.
According to the econometric tests to which I have subjected this indicator and other valuation indicators, it has one of the best, if not the best, track records for predicting the real total return of the stock market over the next decade. .
There are other opposite signs with the same result. Institutional investors over the past 12 months have poured a lot more money into US equity funds that retail investors have taken. And his Rare for the stock market to fall two years in a rowsuggesting that 2023 could be a pivotal year for the S&P 500 index
spx,
after this year’s bear market.
This average allocation to household stocks reached its all-time high, and therefore its most bearish attitude, at 51.73% in March 2000, the month of the peak of the Internet bubble. We all remember what happened next.
This indicator was almost as high as a year ago, in December 2021, at 51.66%. As of the date of this reading, the Vanguard Total Stock Market ETF
vti,
— whose 4,026 shares represent the entire US market — lost 19.9% of its value.
The indicator is updated quarterly, and again with a lag of several weeks. Two weeks ago, the Federal Reserve released the third quarter data which is the inputs for the indicator, and its latest value is 43.62%. While this most recent reading is still above the historical average, it no longer implies a negative real total return for the S&P 500 over the next decade. Instead, he predicts that the stock market will beat inflation by an average of 0.6% per year.
Beating inflation by less than a percentage point may not seem like a big deal to you. But this is the first time since the start of the pandemic that the indicator has projected a positive return.
Also, I wouldn’t be surprised if the stock market over the next decade beats this projected return. This is due to the special circumstances that have caused the indicator to drop over the past year. During a typical bear market, the average household’s portfolio allocation to equities will more or less automatically decline as equities lose ground and bond values rise. When this happens, investors do not need to sell their shares for this average allocation to fall.
In the current bear market, by contrast, bonds have performed as badly as stocks, if not worse. As a result, the decline in the average household’s equity allocation over the past year has been largely driven by actual equity sales. From a contrary perspective, these selloffs have a much more bullish significance than the decline in stock allocations that occurs when stocks fall and bonds rise.
How eight valuation models stack up
The table below lists the eight value indicators that I highlight in this space each month. I don’t know of others with superior historical backgrounds. As is the case with the average household’s equity allocation, many of the other indicators in the chart also retreated from the overvalued extremes at the end of 2021.
| Last | a month ago | Beginning of the year | Percentile since 2000 (100 plus bearish) | Percentile since 1970 (100 plus bearish) | Percentile since 1950 (100 plus bearish) | |
|
P/E ratio |
8:43 p.m. |
21.81 |
24.23 |
40% |
62% |
71% |
|
WTP ratio |
27.97 |
29.86 |
38.66 |
69% |
79% |
85% |
|
P/dividend ratio |
1.74% |
1.68% |
1.30% |
73% |
82% |
87% |
|
P/sales report |
2h30 |
2.45 |
3.15 |
89% |
89% |
89% |
|
P/lb ratio |
3.82 |
4.07 |
4.85 |
90% |
86% |
86% |
|
Q-report |
1.63 |
1.73 |
2.10 |
80% |
89% |
92% |
|
Buffett ratio (market cap/GDP) |
1.51 |
1.61 |
2.03 |
88% |
95% |
95% |
|
Average distribution of household equity |
43.6% |
43.6% |
51.7% |
75% |
84% |
88% |
Mark Hulbert is a regular MarketWatch contributor. His Hulbert Ratings tracks investment newsletters that pay a fixed fee to be audited. He can be reached at mark@hulbertratings.com.
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