Climbing the Wall of Worry
Richard
Bernstein
Climbing the Wall of Worry
December 2012
Most investors have heard the phrase “bull markets climb the wall of worry”. However,
they also have difficulty identifying whether the stock market is indeed in a bull phase that
is climbing the wall of worry or whether fear is justified and the bull market is nearing an
end.
We have observed that portfolios tend to perform less well when emotion is the guiding
force, so we use very objective and well-tested indicators to assess fear in the
marketplace. Currently, these indicators suggest that the bull market remains intact, and
that the market is indeed climbing the wall of worry once again.
In this report, we highlight some of the indicators that we incorporate into our portfolios.
They are uniformly suggesting that investors are too afraid, and that higher US equity
allocations are probably warranted.
The Wall Street Sentiment Indicator
Approximately thirty years ago, we began to study the information content of Wall Street
strategists’ consensus recommended asset allocations. We found, when adding a little
math, that the consensus recommended asset allocation was a very reliable contrary
indicator. That is, it paid to be bullish when Wall Street suggested underweighting
equities, and vice versa.
Chart 1 shows one version of this indicator in which we plot the consensus recommended
equity allocation for a balanced fund against the typical normal long-term equity weight of
60-65%. In this chart, a reading of 50% indicates that the average Wall Street strategist
was recommending 50% of a balanced fund (i.e., stocks, bonds, and cash) be invested in
equities.
As a fantastic example of bull markets climbing the wall of worry, Wall Street strategists
never recommended overweighting equities at any point during the entire bull market of
the 1980s and 1990s. They finally recommended overweighting equities subsequent to
the Technology bubble. That overweight proved to be just in time for the so-called “lost
decade in equities”, during which US stocks produced a negative return over ten years.
Today, however, Wall Street strategists are recommending the lowest equity allocation in
the near-thirty year history of the data. As was the case before the lost decade, the stock
market has performed well during a period of fear.
Richard Bernstein
Advisors LLC
520 Madison Avenue
28th Floor
New York, NY 10022
212-692-4000
www.rbadvisors.com
PAST PERFORMANCE IS NO GUARANTEE OF FUTURE RESULTS
Chart 1:
Wall Street Sentiment Indicator
(as of Oct. 31, 2012)
72
68
64
60
Traditional Benchmark Equity Allocation
60% to 65%
56
52
48
44
Jan-85
Jan-86
Jan-87
Jan-88
Jan-89
Jan-90
Jan-91
Jan-92
Jan-93
Jan-94
Jan-95
Jan-96
Jan-97
Jan-98
Jan-99
Jan-00
Jan-01
Jan-02
Jan-03
Jan-04
Jan-05
Jan-06
Jan-07
Jan-08
Jan-09
Jan-10
Jan-11
Jan-12
40
Source: Richard Bernstein Advisors LLC
ISI Bond Manager Survey
The wall of worry isn’t constrained to the equity market. The treasury market has been
climbing for years a similar wall of worry. Chart 2 depicts the results of a weekly survey of
bond portfolio managers conducted by ISI Group. The graph shows the percent of the
bond portfolio managers who say that their portfolio duration is longer than that of the
benchmark.
Positioning a portfolio with longer duration than benchmark means that a portfolio
manager believes that interest rates are likely to fall, whereas a shorter duration implies
positioning in anticipation of rising rates. The survey results show that bond portfolio
managers have never in the history of the survey positioned for falling interest rates. Yet,
during the time period of the survey, the ten-year treasury note rate has significantly fallen
(see Chart 3). Bond portfolio managers continue to believe that rates will increase.
Many have suggested that there is a “bond bubble”. We find it hard to believe that there is
a bond bubble when bond managers’ portfolios are short duration versus benchmark. If
there were indeed a bond bubble, wouldn’t these managers’ portfolios be extremely long
duration? Rather, it appears that there is a significant wall of worry in the bond market,
and investors might consider positioning for rates that may continue to decrease.
Richard Bernstein
Advisors LLC
520 Madison Avenue
28th Floor
New York, NY 10022
212-692-4000
www.rbadvisors.com
PAST PERFORMANCE IS NO GUARANTEE OF FUTURE RESULTS
2
Chart 2:
Chart 3:
Source: ISI Group
Source: Richard Bernstein Advisors LLC, Bloomberg
Investment flows
We cannot find a period during which mutual fund flows anticipated a bear market.
Rather, the data seem to suggest that significant flows to equity mutual funds are a
warning signal, whereas significant outflows suggest opportunity. This cycle has so far
fit that historical norm.
Chart 4 shows the wall of worry among mutual fund investors. Despite that the S&P
500 has produced a total return of about 15% over the past year, mutual fund investors
have been consistent sellers of US equities.
Richard Bernstein
Advisors LLC
520 Madison Avenue
28th Floor
New York, NY 10022
212-692-4000
www.rbadvisors.com
PAST PERFORMANCE IS NO GUARANTEE OF FUTURE RESULTS
3
Chart 4:
Domestic Equity Rolling 12 month flows
(March 2009 - October 2012)
S&P 500®
Index Level
($ mil.)
200,000
1600
Domestic Equity Rolling 12-month flows
150,000
S&P 500® Index
100,000
1400
50,000
0
1200
-50,000
-100,000
1000
-150,000
Sep-12
Mar-12
Sep-11
Mar-11
Sep-10
Mar-10
Sep-09
800
Mar-09
-200,000
Source: Richard Bernstein Advisors LLC, ICI, Standard & Poor's
Fears of inflation dominate
There appears to be a wall of worry with respect to inflation as well. It is unfortunate that
investors have listened to politicians because printing money does NOT cause inflation.
Economic textbooks say that printing money and using it to create excess credit causes
inflation. The US is certainly printing money, but credit creation could hardly be called
active let alone excessive. Thus, we view the risk of meaningful inflation as still quite low.
However, investors continue to perceive inflation risk to be very high. Our models
currently suggest that investors are pricing nearly 6% inflation over the next twelve
months into the valuation of the stock market. As Chart 5 shows, such expectations have
nearly always been too pessimistic. The stock market appears to be climbing the inflation
wall of worry as well.
Richard Bernstein
Advisors LLC
520 Madison Avenue
28th Floor
New York, NY 10022
212-692-4000
www.rbadvisors.com
PAST PERFORMANCE IS NO GUARANTEE OF FUTURE RESULTS
4
Chart 5:
Inflation vs. Inflation Expectations
Dec. 1987 - Oct. 2012
8.0%
6.0%
4.0%
2.0%
0.0%
-2.0%
CPI Y/Y %
CB Inflation Expectation NTM (12 mos. Lead)
1987
1989
1990
1991
1992
1993
1994
1996
1997
1998
1999
2000
2001
2003
2004
2005
2006
2007
2008
2010
2011
2012
2013
-4.0%
Over-estimating the risks within the US
We continue to have a bullish view of the US equity market because investors seem to be
overestimating the risks within the US economy and for US corporate profits. The wall of
worry can be a high one, and these indicators lead us to think that the bull market is likely
to continue for longer than investors currently expect.
Richard Bernstein
Advisors LLC
520 Madison Avenue
28th Floor
New York, NY 10022
212-692-4000
www.rbadvisors.com
PAST PERFORMANCE IS NO GUARANTEE OF FUTURE RESULTS
5
INDEX DESCRIPTIONS:
The following descriptions, while believed to be accurate, are in some cases abbreviated versions
of more detailed or comprehensive definitions available from the sponsors or originators of the
respective indices. Anyone interested in such further details is free to consult each such sponsor’s
or originator’s website.
The past performance of an index is not a guarantee of future results.
Each index reflects an unmanaged universe of securities without any deduction for advisory fees
or other expenses that would reduce actual returns, as well as the reinvestment of all income and
dividends. An actual investment in the securities included in the index would require an investor to
incur transaction costs, which would lower the performance results. Indices are not actively
managed and investors cannot invest directly in the indices.
S&P 500® Standard & Poor’s (S&P) 500® Index. The S&P 500® Index is an unmanaged,
capitalization-weighted index designed to measure the performance of the broad US economy
through changes in the aggregate market value of 500 stocks representing all major industries.
Consumer Price Index (CPI): The CPI is a measure of the average change in prices over time of
goods and services purchased by households. The CPI is based on prices of food, clothing,
shelter, and fuels, transportation fares, charges for doctors' and dentists' services, drugs, and other
goods and services that people buy for day-to-day living. Source: Bureau of Labor Statistics
© Copyright 2012 Richard Bernstein Advisors LLC. All rights reserved.
Richard Bernstein
Advisors LLC
520 Madison Avenue
28th Floor
New York, NY 10022
212-692-4000
www.rbadvisors.com
Nothing contained herein constitutes tax, legal, insurance or investment advice, or the
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investment's value. Past performance is, of course, no guarantee of future results.
PAST PERFORMANCE IS NO GUARANTEE OF FUTURE RESULTS
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