The average equity allocation has risen to over 40%. Previous high levels have preceded bear markets.
If your allocation to stocks is higher on a percentage basis than it’s been in a while, you’re not alone.
According to a fresh piece by financial blogger Ben Carlson, the average U.S. investment allocation to stocks has risen in recent years to more than 40%, which is higher than it was at the last stock-market peak in 2007.
The data Carlson uses is supplied by Federal Reserve Economic Data or FRED, a database maintained by the research division of the Federal Reserve Bank of St. Louis.
“There have only been two times since World War II that allocations to stocks have been higher — after the go-go years of the 1960s and at the height of the dot-com bubble in the late 1990s,” writes Carlson, the director of institutional asset management at Ritholtz Wealth Management and the author of the popular Wealth of Common Sense blog.
Carlson states that previous high levels in equity allocations have preceded bear markets. Certainly, the 1970s was a bad decade to be in equities, as were the two years following the tech bust of March 2000.
Coupled with above-average valuations, many see this rising level of total assets allocated to stocks as a reason to be cautious on stocks in the future, Carlson adds.
To be sure, having roughly 40% to 45% of one’s investment assets in stocks is not in and of itself foolishly exuberant, especially in an age of low interest rates and likely diminished returns for bonds.
But when you consider that the average weighting in stocks has climbed from 25% in 2008 to more than 40% this year, it does suggest that many Americans are perhaps becoming a bit too reliant on the asset class, a factor that has helped to drive up values.
With most economists seeing a slim chance of recession on the horizon, stocks could keep on rising for a while. Still, it’s not a good sign that stocks — as a percentage of total assets — are now approaching levels where prices have topped out in the past.
Meanwhile, in a piece for Project Syndicate, market strategist Mohamed El-Erian argues that it’s “too soon to give the financial system a clean bill of health,” despite comments from policy makers in recent weeks suggesting that the system is sound and stable.
Some might argue that El-Erian, the chief economic advisor to German financial services giant Allianz, is being a bit too contrary here. After all, the Federal Reserve announced in June that all U.S. banks passed its latest annual stress test. And Fed Chair Janet Yellen has suggested that the U.S. could go for decades without experiencing another financial crisis.
But El-Erian sees risks for the system that aren’t being properly acknowledged.
“First, as more carefully regulated banks have ceased certain activities, voluntarily or otherwise, they have been replaced by non-banks that are not subject to the same supervisory and regulatory standards,” he writes.
In addition, he writes, certain segments of the non-bank system are now in the grips of a “liquidity delusion,” in which some products risk overpromising the liquidity they can provide for clients transacting in some areas — such as high-yield and emerging-market corporate bonds — that are particularly vulnerable to market volatility. “And at the same time, exchange-traded funds have proliferated, while financial intermediaries have shrunk relative to bigger and more complex end users,” he adds.
He concludes: “To be sure, another systemic financial crisis that threatens growth and economic prosperity worldwide likely won’t originate in the banking system. But it would be premature to assert that we have put all the risks confronting the financial system behind us.”
As El-Erian makes clear, declaring victory in the war against future financial crises is a dangerous thing.