Reinventing Your Retirement New Realities For New Challenges For Clear View
Summer Intern Project - Grace Chmiel
1. Stability Investment Solutions Diligence Client-centric
A Psychological Analysis of the Current
Investor Sentiment and Positioning
Presented to:
Global Allocation Fund
Steve Auth & Team
Presented by:
Grace Chmiel
Summer Intern: Investment Management - Global Equity
Department
Distributor Information/Disclosure/Product Code or Tracking Number
2. Key Question
Did the '08-'09 bear market so scar investors
that their "normal" balancing of risk and reward
was semi-permanently thrown off balance?
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3. Bottom Line
Investors are psychologically scared from the 08/09 Great Recession. Without recognizing the
psychological impact the Great Recession had, investors rely on traditional economic approach to
analyze current market trends which – by definition includes human judgment to make decisions –
thereby blurring the investors lens to foresee a positive end market.
They have Psychological Constraints:
Heuristics
Over confidence
Narrowing framing
Much more sensitive to losses than gains
Aversion to ambiguity
Fear of regret
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4. If “yes,” then we should observe…
1. The traditional "Wall of Worry" which fuels bull markets should last longer than usual
2. "Animal Spirits" which drive economic activity should take longer to recover
3. Portfolio management models built on extrapolating past risk reward relationship may miss
estimate future market returns
4. Government officials responsible for the economy (eg the Fed) should be likely to take
longer to raise rates/tame the recovery
5. Equities should be likely to remain under fair value or normal value vs bonds for longer than
usual
6. Investors should be slow to re-allocate into equities
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American Association of Individual Investors
The Traditional “Wall of Worry” which fuels bull markets should last longer
than usual
AAII survey measures the percentage of individual investors who are bullish,
bearish, and neutral on the stock market for the next six months
The Savvy Investor knows to pay attention to general market conditions like “irrational exuberance” and the “wall or
worry”
Like Warren Buffett once said: “We simply attempt to be fearful when others are greedy and to be greedy when others
are fearful.”
The first sign of this: Sentiment Surveys are reporting Investors are leaning Bearish on the stock market for the next six
months
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Even in recent weeks, investors continue to sway neutral/bearish
The Traditional “Wall of Worry” which fuels bull markets should last longer
than usual
But are they doing what they are saying?
Shift to Bear Sentiment
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5.88%
16.04%
1.02%
51.56%
24.30%
1.14%
2007
4.85%
14.56%
3.42%
47.70%
26.63%
3.36%
2013
Investors are doing what they are “saying.”
Current Bull Market show significant asset allocation changes relative to previous bull markets
The Traditional “Wall of Worry” which fuels bull markets should last longer
than usual
5.36% 6.37%
0.77%
63.17%
20.45%
3.88%
Asset Allocation 1998
Cash
Domestic Bonds
International Bonds
Domestic Equity
International Equity
Other
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Based on “averages”, this current 2009 Bull Market should expect a recession soon
Example: In the past 11 business cycles between 1945-2009, as defined by NBER, the average trough to
trough lasts 69.5 months. Since NBER defined end of Great Recession in June 2009 – it’s been 60
months – 9.5 months away from next expected recession (on average)
Traditional “Animal spirits” have dissipated due to contagious bear ideas
"Animal Spirits" which drive economic activity should take longer to recover
9. "Animal Spirits" which drive economic activity should take longer to recover
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Bear Markets: Average % drop in S&P 500
• Little Bear : - 21.51%
• Big Bear: - 49%
• 08/09 Crash: - 57%
84.70% 89.00%
111%
170%
185%
0.00%
20.00%
40.00%
60.00%
80.00%
100.00%
120.00%
140.00%
160.00%
180.00%
200.00%
Little Bear Big Bear Big Bear (excluding
'37)
2013 August 2014
% Move off Low on S&P 500 5 Years Out of Bear Market
---------------
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-66%
-48%
-10% -4%
26%
38%
-80%
-60%
-40%
-20%
0%
20%
40%
60%
1929 - 1933 1937 - 1938 1973 - 1974 2001 - 2001 2007 - 2009 Little Bear
Where were the Big Bear markets 5 Years Out compared
to previous high in S&P 500?
% abv/blw
Previous High
on S&P 500
"Animal Spirits" which drive economic activity should take longer to recover
This suggests
we have
room to grow
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3.17%
4%
1.80%
0.00%
0.50%
1.00%
1.50%
2.00%
2.50%
3.00%
3.50%
4.00%
4.50%
Little Bear Big Bear 2013
GDP Growth Rate 5 Years Out
GDP Growth Rate
* Zarnowtiz Rule: deep recessions follow steep recoveries
"Animal Spirits" which drive economic activity should take longer to recover
5 Years Out after
Big Bear
GDP
Growth Rate
1937 5.10%
1943 17%
1979 3.20%
2006 2.70%
12. Government Officials responsible for the economy should be likely to take
longer to raise rates/ tame the recovery
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4.67%
11%
0%
0.00%
2.00%
4.00%
6.00%
8.00%
10.00%
12.00%
Little Bear Big Bear 2014
Average Fed Funds Rate 5 Years Out
Fed has learned from its mistake from the Great Recession and it is
maintaining a low interest rate for a longer period of time
The lack of fiscal policy has hurt GDP growth
13. Portfolio Management Models built on extrapolating past risk reward relationship may
miss estimate future market returns
The past 10 years were far from “normal”
Great Recession was about 2 standard deviation increase in volatility
One standard deviation increase in volatility was associated with a 0.5% reduction in annual growth
(Ramey and Ramey, 1995)
Lower consumer spending (Romer 1990)
Investment and hiring (Bloom 2009)
Trade (Handley and Limao 2012, Novy and Taylor 2012)
Exposure to exogenous variations in energy and currency volatility depresses investment, hiring and advertising
Uncertainty increases in R&D spending
Firms less sensitive to business conditions drivers like demands, prices and productivity
High uncertainty can reduce the impact of stimulus policies like interest rate and tax cuts
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14. As of June 2, 2014.
Past performance is no guarantee of future results.
This chart is for illustrative purposes and not representative of a specific investment.
S&P 500 is a free-float capitalization-weighted index published since 1957 of the prices of 500 large-cap common stocks actively traded in the United States.
EPS = Earnings Per Share
P/E = Price to Earnings
March 24, 2000
$1,527.46
$56.13 EPS
27.2x P/E
6.79% 10 Year Treas
Implied Target P/E 14.7x
Overvaluation 85%
August 25, 1987
$336.77
$19.55 EPS
17.2x P/E
8.78% 10 Year Treas
Implied Target P/E 11.4x
Overvaluation 51%
March 6, 2009
$666.79
$61.00 EPS
10.9x P/E
2.055% 10 Year Treas
Implied Target P/E 48.7x
Undervaluation 78%
October 4, 2011
$1,074.77
$96.57 EPS 2011E
11.1x P/E
1.67% 10 Year Treas
Implied Target P/E 59.9x
Undervaluation 81%
June 4, 2012
$1,266.74
$104.44 EPS 2012E
12.1x P/E
1.44% 10 Year Treas
Implied Target P/E 69.4x
Undervaluation 83%
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Current Valuation
May 29, 2014
$1,920.00
$117.00 2014E EPS
16.4x P/E
2.40% 10 Year Treas
Implied Target P/E 41.7x
Undervaluation 61%
Equities should be likely to remain below fair value or normal value vs bonds for longer
than usual
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0
100
200
300
400
500
600
700
0-1
yrs
1-2
yrs
2-3
yrs
3-4
yrs
4-5
yrs
5-6
yrs
6-7yrs 7-8
yrs
8-9
yrs
9-10
yrs
10-15
yrs
15+
yrs
#ofManagers
# of Years with Fund
22.25%
24.67%
20.55%
12.56%
10.57%
7.05%
2.35%
% of Total Mangers by # Years with
Fund
>2 yrs
2-4 yrs
4-6 yrs
6-8 yrs
8-10 yrs
10-15 yrs
15+ yrs
1/3 of Managers of have been with a
Fund for 6+ years
# of Managers Organized by # Years with Fund
Investors should be slow to re-allocate into equities
…Because of the lack of cognitive diversity
Cognitive Diversity allows investors to rebalance the thrown off “risk and reward” by
adding unique perspectives that would otherwise be absent. It also takes away or least
weakens, some of the destructive characteristics of group decision making.
16. Appendix
Bear Market
5 Years Out
(12-31-19xx)
% down in S&P
500
% Move off Low 5
Years Out
%Move off Low
(Cycle Peak)
% abv/blw
Previous High 5
years Out
GDP Growth Rate 5
Years Out
Yield on 10yr Note 5
Years Out
P/E Fed Funds Rate 5
Years Out5 Years Out
1929 - 1933 1937 -84.80% 169% 322% -66% 5.10% N/A 10.5 N/A
1937 - 1938 1943 -54.50% 25% 145% -48% 17% N/A 12.6 N/A
1945 - 1946 1949 -28% 70% 90% 23% 8.7% N/A 7.5 N/A
1948 - 1949 1954 -21% 158% 96% 105% -0.6% N/A 12.6 1%
1957 - 1958 1963 -20.50% 62% 84% 7% 4.4% 4.1 18.8 3.5%
1960 - 1961 1965 -28% 84% 105% 31% 6.5% 4.7 17.8 4.3%
1965 - 1967 1971 -22% 40% 83% -6% 3.30% 5.9 18.0 4.9%
1969 - 1970 1975 -36% 30% 73% -25% -0.2% 7.76 11.8 7.5%
1973 - 1974 1979 -48% 74% 125% -10% 3.20% 10.3 7.4 15.5%
1981 - 1982 1987 -26% 141% 228% 139% 3.50% 8.85 14.0 8.5%
1987 - 1988 1993 -33% 93% 114% 30% 2.70% 6.6 21.3 3%
2001 - 2001 2006 -49% 89% 101% -4% 2.70% 4.71 17.4 6.75%
2007 - 2009 2013 -57% 170% 185% 26% 1.80% 3.04 19.1 0%
Average -37.57% 86.22% 130.50% 14.68% 3.42% 7.3 14.1 6.11%
Big Bear
(x < - 40) -59% 89% 173% -32% 4% 7.5 12.0 11%
Little Bear
(-40 < x < - 20) -26.81% 84.70% 109.13% 38.03% 3.17% 7.1 15.2 4.67%
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NBER defined 11 recessions between 1945- 2009
On Average:
• Contraction – peak to trough: 11.1 m
• Expansion – previous trough to this peak: 58.4 m
• Trough from previous trough - 69.5 m
• Peak from previous peak – 68.5 m
Since NBER defined end of Great Recession in June 2009 – it’s been 60 months – 8.5 months away from
next expected recession (on average)
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3.98
19.63
5.28
62.01
3.60 1.68
Federated Asset Allocation 1998
Cash
Domestic Bonds
Internation Bonds
Domestic Equity
Internation Equity
Other
1.97
16.82
5.40
31.45
40.36
3.39
Federated 2013
2.79
22.83
1.82
33.72
35.73
0.74
Federated 2007
Appendix
*Federated average Tenure Manger : 7.09 years