CHAPEL HILL, N.C. (MarketWatch) — Might the Nasdaq Composite’s rise this week above its previous high from the top of the Internet bubble represent the bull market’s last gasp?
It’s not out of the question: U.S. households are now allocating more of their investment portfolios to equities than at any other time over the past six decades, with just two exceptions: the market tops in 2000 and 2007.
This bodes poorly for the stock market’s prospects over the next decade, according to Ned Davis, founder of Ned Davis Research. Since 1952, he found, the stock market has produced average 10-year annualized returns in the low single digits following readings as high as today’s.
It will undoubtedly come as a surprise to many of you that households’ equity allocations are at close to record highs, since the financial media in recent months have been serving up a steady drumbeat of stories about how the average investor, traumatized by the memory of the 2008-2009 Great Recession, is out of the stock market entirely.
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But Davis lets the data speak for themselves: Since 1952, the equity portion of households’ investment portfolios has averaged 44.8%. Its level today is 56.9%. It hit a low of 37% at the end of the 2007-2008 bear market.
The above chart from Davis correlates household equity allocation to the S&P 500’s SPX, -0.54% return over the subsequent 10 years. Note that the S&P 500’s return is on an inverted scale, showing — just as contrarian analysis predicts — that higher allocations are associated with lower subsequent 10-year returns.
To appreciate how closely the market’s 10-year returns follows changes in household equity allocation, consider the correlation coefficient. Its highest possible reading would be plus 1 (if the two series were perfectly correlated), while a zero coefficient would mean there is no detectable relationship. According to Davis, the correlation coefficient for the two series in his chart is an extremely high 0.94 — which he terms “remarkable.”
Fundamental analysis adds credence to the bearish implication of Davis’ contrarian analysis: It’s hard to see how the sales growth of U.S. corporations will grow fast enough over the next decade .to support equity returns that are anywhere close to historical averages.
Take a look at the accompanying graph, which plots the growth since the early 1990s of the U.S. gross domestic product and the S&P 500’s per-share sales and earnings.