Part of the reason this relationship may exist is due to valuation; high equity ownership periods are generally associated with high valuation periods. Another reason it may exist is a related construct from the fields of sociology and behavioral finance: thresholds. Sociologist Mark Granovetter, in his paper Threshold Models of Collective Behavior, identifies that group outcomes are dependent upon the various thresholds of the members. In this case, a threshold for an individual is based on how many other individuals are engaged in the behavior. In financial markets we can think of a low-threshold actor as a contrarian, meaning they favor of non-consensus ideas. Similarly, we can think of high-threshold investors as “herd,” meaning they only participate after a large amount of reassurance. The problem is that by the time high-threshold entrants are sufficiently convinced to enter the market, the majority of the trend is over and there are few new entrants (with seemingly even higher thresholds) to push the market to new heights. This would mean the highest-threshold entrants generally enjoy the lowest returns. Using the chart above as a guide, any investor currently jumping into stocks after such a prolonged bull run (which we could call a high-threshold actor) should expect below average returns over a long holding period.
Though the threshold model may not be a pure comparable to the equity ownership charts above, we think it is fair to wonder, with household ownership approaching record levels, who is the marginal buyer of equities these days? One question that always comes up in these analyses is to wonder if “this time is different,” particularly given low interest rates globally, which push investors out on the risk curve and could theoretically cause a new higher stock ownership paradigm. Another potential answer is trend-following strategies and quasi-trend, vol-driven strategies like risk-parity, which some estimates put at $8 trillion globally in aggregate, and are natural buyers of equity markets in a stable up-trend with low volatility. Then there are the indiscriminate buyers, such as corporate buybacks, which have fallen to only $500 billion on a rolling 12-month basis. Let’s not forget the Bank of Japan, which owns an alarming proportion of Japanese ETF issuance.
High-threshold actors… indeed. You can find Artie and Charlie’s full piece here.
In past valuation posts, I’ve occasionally shared the following two charts. Ned Davis Research (NDR) charts the Federal Reserve’s “U.S. Household Asset Allocation” data. Below is the charted history of stock, bond and cash percentages. Stock ownership is currently 55.83% of a “Household’s” asset allocation (upper section of next chart).
NDR looks at that stock allocation number (55.83% today) and they then do something really cool. They analyze the history of the percentage in stocks and plot the returns an investor received ten years later.
Much as Artie and Charlie detailed in their commentary, NDR finds the same evidence. High equity ownership means so much money has bought in and bids up prices. When most are in, there are fewer buyers to buy and pushes prices higher. The “really cool” chart is next.
Here’s how to read it:
- The blue line is the “Household Equity Percentage” – numbers on left-hand axis. The current number is 55.83%.
- The dotted black line is the actual “Subsequent Rolling 10-Year Total Return.”
- Red boxes mark dates in time. Arrows point to the return achieved or projected if the 10-year period has not yet finished.