By Mark Hulbert
The most important stock-market-related news of the past three months was released this week, and I bet you didn’t notice.
It was imbedded in a report that the Federal Reserve released Thursday, its quarterly update of the Financial Accounts of the United States . Among that report’s myriad statistics was the average household’s portfolio allocation to equities.
That single statistic is the basis of the stock-market indicator that its creator has called, with some justification, the “single greatest predictor of stock market returns.” It is the brainchild of the anonymous author of the Philosophical Economics blog .
I am unaware of any other indicator that has a better track record when predicting the S&P 500’s (S&P:SPX) total real return over the subsequent 10 years. As measured by a statistic known as the r-squared , the indicator since 1951 has been able to predict 70% of the changes in the stock market’s 10-year return. If you know of any indicator that does better than that, please let me know.
One reason why I bet you didn’t notice this week’s release of this all-crucial indicator is that it’s not a short-term market-timing tool. It is updated only quarterly and has a time lag. And, by focusing on where the market may be in 10 years’ time, it tells you nothing about the path the market may take in getting there.
The even bigger reason why the indicator may have been so widely overlooked this week: Its message is hardly welcome. Its implicit forecast is that the stock market will be significantly lower in inflation-adjusted terms in a decade.
The average household’s portfolio allocation to equity currently stands at 50.9%. As you can see from the accompanying chart, below, it is a contrarian indicator, with higher allocations associated with lower stock market returns over the subsequent decade. The current reading is higher than all but one period since 1951.
That lone exception came in the first quarter of 2000, right at the top of the internet bubble. That quarter’s reading stood at 51.8% — just 0.9 of a percentage point higher than the latest reading.
How bearish is the indicator currently? According to a simple econometric model based on the historical relationship between the indicator and the stock market, the indicator is projecting that the S&P 500 will produce a total real return of minus 4.2% annualized over the next decade.
Update on valuation indicators
I also want to report the latest values of the eight indicators I report each month in this space, my monthly review of the status of valuation indicators with the best record predicting the stock market’s 10-year returns. As you can see, it’s not just the average household’s equity allocation that is bearish about the stock market’s longer-term prospects.
|Latest||End of last month||Beginning of year||Percentile since 2000 (100 most bearish)||Percentile since 1970 (100 most bearish)||Percentile since 1950 (100 most bearish)|
|Buffett ratio (Market cap/GDP )||2.01||2.06||1.82||99%||100%||100%|
|Average household equity allocation||50.9%||49.5%||47.6%||99%||99%||99%|
Mark Hulbert is a regular contributor to MarketWatch. His Hulbert Ratings tracks investment newsletters that pay a flat fee to be audited. He can be reached at firstname.lastname@example.org .