An investor’s willingness to invest in stocks varies with the level of the S&P 500 index and other major indexes. Similarly, in aggregate, older investors tend to be more conservative than younger investors. Neither statement should be a surprise to those of you who have been investing for a long time and/or are familiar with market cycle trends in the investment industry.
A recently published study in the Journal of Behavioral Finance looked at the link between age, risk tolerance and the S&P 500. It sought to determine whether older investors exhibited greater risk aversion when the index declined in value than younger investors did. In other words, the study’s authors weren’t trying to confirm whether older investors are less inclined to risk capital in hopes of future gain during declining markets, but whether their risk aversion increases more than comparatively younger investors.
Risk aversion was assessed through a questionnaire given to participants of defined-contribution plans [e.g. 401(k) plans] offered through Morningstar Associates. (More on using questionnaires to assess risk in a moment.) Approximately 29,000 investors were surveyed. The correlation between average monthly risk aversion and the S&P 500 was –0.46 for the 51- to 65-year-old age group versus –0.20 for the 20- to 35-year-old age group. The negative numbers show that investors’ aversion to incurring a loss declined as the S&P 500 went up and increased as the large-cap index declined. The larger negative correlation for older investors indicates a stronger inverse relationship between risk aversion and the stock market’s performance.
The relationship is not perfect. A correlation of –1.00 would indicate a direct negative relationship. For example, for every 1% decline in the S&P 500, an investor’s risk aversion would increase by 1% and vice versa. The fact that the correlation for the younger investors is closer to zero shows that those in this group are less sensitive to swings in value of the S&P 500 than those in the older group. This makes sense because older investors are more likely to rely on their portfolios to cover living expenses, lack salaried income and have shorter investing time horizons. Young investors, conversely, may not need to withdraw from their portfolio for three or more decades.
The level of aversion among both young and old investors did change with the market conditions. During the last bear market, the correlations between risk aversion and the S&P 500 were –0.296 and –0.696 for the young and old investor groups, respectively. Notice how both turned more negative, indicating greater risk aversion as the stock prices fell. During the subsequent market rebound (2009 through 2012), the correlations turned slightly positive at 0.158 and 0.022, respectively. Younger investors began to show slightly more caution when stock prices rose, while risk aversion among older investors essentially became uncorrelated with how the S&P 500 performed.
The changing nature of risk aversion should give you pause if you’ve ever used a risk questionnaire to determine your suggested allocation. Questions about your willingness/ability to incur market-driven losses will elicit different answers depending on the current state of the market. You may feel far more confident about your ability to withstand a loss when stocks are doing well and volatility is low than when the S&P 500 is falling and volatility is high. Good market conditions may cause your perceived ability to tolerate risk to be higher than it actually is, while bad market conditions may lead you to adopt a more conservative allocation than you are actually able to tolerate.
- Stress Hormone Alters Tolerances for Financial Risk – A sustained increase in cortisol reduces tolerance for risk and increases preferences for lower-returning, less-volatile investments.
- Why Gender Tolerances Toward Risk May Differ – Women tend to be less risk tolerant than men, especially when their income is uncertain.
- The Cost of Panicking – Getting out of the market due to fear over falling prices has a lasting, negative impact on your wealth.
- A Simple Way to Fund Retirement – Delaying when Social Security benefits are claimed and using required minimum withdrawals to provide any additional income should work well for most middle-income retirees.
Hardinge Inc. (HDNG) was removed from the Model Shadow Stock Portfolio after agreeing to be acquired by an affiliate of Privet Fund Management LLC. Privet will acquire all shares of Hardinge stock it does not currently own for $18.50 in cash. To replace Hardinge, Container Store Group Inc. (TCS) was added.
At the end of February, 11 current Shadow Stock holdings qualified for purchase. Those stocks are Aceto Corporation (ACET), Amira Nature Foods Ltd. (ANFI), AutoWeb Inc. (AUTO), Delta Apparel Inc. (DLA), Hallador Energy Co. (HNRG), Olympic Steel Inc. (ZEUS), Rocky Brands Inc. (RCKY), Seneca Foods Corp. (SENEA), SigmaTron International (SGMA), Strattec Security Corp. (STRT) and Townsquare Media Inc. (TSQ).
Last month, the Model Shadow Stock Portfolio, which is a real-money portfolio of micro-cap value stocks, fell 6.6% in February. The Vanguard Small Cap Index fund (NAESX) fell 4.1% for the month, and the DFA U.S. Micro Cap fund (DFSCX) lost 4.3% in January. Since its inception in 1993, the Model Shadow Stock Portfolio has a compound annual average return of 15.4% versus the Vanguard 500 Index fund’s (VFINX) gain of 9.5% per year and the Vanguard Small Cap Index fund’s (NAESX) average annual gain of 10.2%.
This Saturday is St. Patrick’s Day; wear something green.
Just as fourth-quarter earnings season has ended, we’ll start to get a look at first-quarter results. Dow Jones industrial average component Nike Inc. (NKE), which will report on Thursday, will be joined by 10 other members of the S&P 500. Included in this group are Oracle Corp. (ORCL) on Monday; FedEx Corp. (FDX) on Tuesday; and Accenture PLC (ACN) and Micron Technology Inc. (MU) on Thursday.
The Federal Open Market Committee will hold a two-day meeting starting on Tuesday. A quarter-point rate hike is widely expected to be announced when the meeting statement is released on Wednesday at approximately 2 p.m. Eastern Time. Updated committee member forecasts will be released at the same time. Jerome (“Jay”) Powell will hold his first press conference as Federal Reserve chair at 2:30 p.m.
Elsewhere on the economic calendar, February existing home sales will be released on Wednesday. Thursday will feature the March flash composite Purchasing Managers’ Index (PMI). February durable goods orders and February new home sales will be released on Friday.
Two Federal Reserve officials will make public appearances: Atlanta president Raphael Bostic on Monday and Friday, and Minneapolis president Neel Kashkari on Friday.
The Treasury Department will auction $11 billion of 10-year inflation-indexed securities (TIPS) on Thursday.
- The Essence of the Benjamin Graham Approach
- Retirement Planning Strategies Following the 2017 Tax Act
- Tax Guide Update: The Tax Cuts and Jobs Act and 2018 Taxes
The percentage of individual investors who expect stock prices to fall plunged to its second-lowest level of the year in the latest AAII Sentiment Survey. At the same time, neutral sentiment stayed at an unusually high level.
Bullish sentiment, expectations that stock prices will rise over the next six months, rebounded by 10.4 percentage points to 36.8%. Even with the increase, optimism is below its historical average of 38.5% for the fourth time in six weeks.
Neutral sentiment, expectations that stock prices will stay essentially unchanged over the next six months, pulled back by 3.4 percentage points to 41.8%. This is the first time neutral sentiment is above 40% on consecutive weeks since June 29, 2017, through July 13, 2017. The historical average is 31.0%.
Bearish sentiment, expectations that stock prices will fall over the next six months, tumbled 7.1 percentage points to 21.3%. Pessimism was last lower on January 3, 2018 (15.6%). The drop keeps bearish sentiment below its historical average of 30.5% for the 13th time in 14 weeks.
Pessimism is near the lower end of its typical historical range. The breakpoint between typical and unusually low readings (defined as one standard deviation below average) is currently 20.7%. Neutral sentiment is at unusually high level for a second consecutive week. Since our survey was started in 1987, the S&P 500 index has experienced average six-month returns following unusually high neutral sentiment readings.
Many individual investors are anticipating continued volatility and/or think the political backdrop could have a further impact on the stock market. Trade policy is influencing some individual investors’ sentiment, but not all. Similarly, higher interest rates are having an influence on some, but not all. Also influencing sentiment are valuations, tax cuts, earnings and economic growth.
This week’s special question asked AAII members how the possibility of a change in foreign trade policy is impacting their expectations of how stocks will perform. Responses were mixed. Just under two out five respondents (39%) expressed concerns about the new tariffs negatively affecting stocks and the economy. Slightly more than 25% of all respondents don’t expect any lasting impact on the economy or the stock market. Many of these respondents expressed skepticism about the tariffs actually being put or kept in place; others view any reaction to them as being short-lived. Just under 10% of all respondents say it is too early tell how the economy or the stock market will be affected. Another 10% of respondents are supportive of tariffs and believe they will have a positive impact on the economy.
Here is a sampling of the responses:
- “If a trade war happens, and it is likely, it will drive down the economy.”
- “I really don’t think there is anything here after the dust and noise settle.”
- “In the long run, a positive impact on stocks.”
- “No idea. The president keeps changing his mind.”
- “I expect some stocks will benefit and some will not benefit. It remains to be seen what shakes out.”
Bullish: 36.8%, up 10.4 points
Neutral: 41.8%, down 3.4 points
Bearish: 21.3%, down 7.1 points
Bullish: 38.5%
Neutral: 31.0%
Bearish: 30.5%
Local Chapter Meetings
March 8, 2018 Tariffs and the Market Environment
March 1, 2018 Warren Buffett on Market Volatility, Risk and More
February 22, 2018 The Size Premium Lives, But Not for All Small-Company Stocks
February 15, 2018 IRAs and an Opportunity for Tax Arbitrage
