Streetwise for Sunday, October 31, 2021

Economist and Nobel prize laureate Robert Shiller once wrote that a lack of investor confidence, a pandemic, political polarization, and elevated share prices have sent fears of a major market downturn to levels we have not seen in many years.

While there is no evidence that a major market downturn will occur, it does suggest that there is and always will be a degree of risk in all forms of investment, and equities are no exception.

Schiller based his conclusions on three decades of research on various stock market confidence indexes. The indexes were drawn from surveys of a random sample of high-income individual investors and institutional investors, conducted monthly by the International Center for Finance at the Yale School of Management.

For example, consider the following question:

"What do you think is the probability of a catastrophic stock market crash in the U.S., like that of Oct. 28, 1929, or Oct. 19, 1987, in the next six months, including the case that a crash occurred in the other countries and spreads to the U.S.?"

Shiller bases his results on a rolling six-month average of the percentage of monthly respondents who think that the probability of such a major crash is less than 10 percent.

A year ago, the percentage of individual investors with that level of confidence in the market hit a record low, 13 percent and then about 15 percent a month later, which was still extremely low.

Institutional investors - people who make decisions for pension funds, mutual funds, endowments, and the like - were a bit more confident, with a September reading of 24 percent, but that was extremely low at the time too.

In short, an overwhelming majority of investors said there was a greater than 10 percent probability of an imminent downturn. So here we are a year later and low and behold, no crash. A couple of small downturns yes, but that is the nature of the markets.

Another index, the Valuation Confidence Index, based on the question: "Stock prices in the United States, when compared with measures of true fundamental value or sensible investment value, are: 1. Too low; 2. Too high; 3. About right; 4. Do not know"?

This index tells us the proportion of investors who think the market is not too highly priced. In September 2020, the reading for individual investors stood at 38 percent, far lower than at the bottom of the stock market in March 2009, when it stood at 77 percent. For institutional investors, it was 46 percent versus 82 percent in March 2009. And today? I do not have access to the current data, but I would have to guess it is probably a bit higher. Does that concern me? Absolutely not.

As Bloomberg has pointed out, if you consider all the physical assets owned by all the companies in the S&P 500, all the cars and office buildings and factories and merchandise, then sell them all at cost in one giant sale, they will generate a net sum that does not even come out to 20% of the index's $28 trillion value. The remainder comes from intangibles.

This is, in the broadest sense, a new phenomenon. Back in 1985, before Silicon Valley came to dominate the ranks of America's largest companies, tangible assets tended to be closer to half the market's value.

The shift picked up after the financial crisis of 2008 and is taking off anew during the Covid-19 lockdown, with the value of intangible-heavy companies like Google and Facebook soaring while smokestack stocks languish. All of which is a source of deep concern for those who worry about things like employment and inequality.

The rise of intangibles helps explain why many American workers have recently had it so rough, with wages stagnating and benefits disappearing, and signals the slide could continue, according to Baruch Lev, the New York University professor whose writings have ignited a debate on the topic in academia. Put simply, these assets do not require the hordes of workers to create and maintain them the way old economy ones did.

However, what we are seeing recently as the impact of the Covid pandemic has come under a degree of control and the demand for labor has increased dramatically, things are beginning to shift towards the labor force and its demands for increased benefits and pay.

Lauren Rudd is a Managing Director with Raymond James & Associates, Inc., member NYSE/SIPC. Contact him at 941-706-3449 or Lauren.Rudd@RaymondJames.com. All opinions are solely those of the author. This material is provided for informational purposes only, is not a recommendation and should not be relied on for investment decisions. Investing involves risk and you may incur a loss regardless of strategy selected. Past performance is no guarantee of future results.