Households' Equity Ownership Reaches 30%. It's Statistical Noise

Summary: Households have 30% of their financial assets in equities, the same proportion as they held at bull market peaks in the 1960s and in 2007. Does this mean another bear market is imminent? No. Two of the last three times the purportedly significant 30% level has been reached, stocks gained another 40-60%. The level is statistical noise.

Households' equity ownership proportion mostly reflects the appreciation in the stock market: their equity proportion fell almost in half in the last bear market yet during this time, investors actually added new money to equity funds. The level of households' assets in equities seems to closely predict high and lows in the stock market because they both measure the exact same thing: the level of the stock market.

There are better ways to measure investor sentiment and valuations, both of which, like the equity proportion, rise during bull markets and fall during bear markets.

Chances are you have seen a chart like the one below. It shows US households' equity ownership as a proportion of total household financial assets (blue line) versus the stock market (red line). The message is usually this: US households now own more equity than at the stock market peak in 2007. It's a sign that another bear market is imminent. Enlarge any chart by clicking on it.

Is it a sign the bull market is at an end? The short answer is no.

It's true that households' "equity proportion" of their financial assets equalled 29% in June 2007 and that it is now 30%. It's also true that bull market peaks in both early 1966 and late 1968 corresponded to the equity proportion reaching 30% and 31%, respectively. Aside from the 1998-2000 tech bubble blow off top, that 30% area has seemed to be where bull markets have died.

But there are two problems with this line of thinking.

The first is empirical. In the past 50 years, the equity proportion has reached this level only 5 times. It was a bull market peak three times (1966, 1968 and 2007) and it was nothing two times (1998 and 2013). A small sample size with a success rate close to a coin toss is statistical noise.

The 29% equity proportion level was reached in late 1997; between 1998 and 2000, SPX gained another 60% (total return basis). The 29% equity proportion was also reached in December 2013. Since then, SPX has gained another 40%. Foregoing an equity return of 40-60% in order to avoid a loss of 22-36% (1966 and 1968 bear markets, respectively) makes this measure of risk even less useful.

Moreover, two of the biggest bear markets in the past 50 years started when the equity proportion was well below 29%. In late 1973, the equity proportion was only 23%; SPX fell almost 50% in the next 11 months. The 1987 crash occurred when the equity proportion was just 18%.

So to summarize, bear markets have started when the equity proportion was much lower than now and strong bull markets have continued much higher over a period of years from the current level. This makes this measurement effectively useless at predicting turns in the stock market.

The second, and bigger, problem with the equity proportion is that it doesn't represent what its proponents believe it represents. The explicit interpretation of this chart is that investors' appetite for stocks is saturated when their equity ownership reaches 30% of their total financial assets. With no fuel left to propel the market higher, investors then sell stock into a bear market. And when their equity ownership reaches an exhaustive low, equities bottom and then begin a new bull market.