US stocks are expensive. Maybe you heard. Maybe you noticed. Maybe you bought them anyway. Probably.
The valuation premium for US shares is well-documented, and as discussed here on any number of occasions over the past two or so years, a lot of it comes down to the mega-caps and specifically to the notion that America’s largest companies are in pole position at the dawn of what Jensen Huang’s fond of calling a “new industrial revolution.”
If you ask JPMorgan, though, valuation expansion for US stocks is best explained as a function of increased retail investor participation and accordingly higher household equity allocations.
The chart’s straightforward. Indeed, I suspect it’s a little too straightforward for its own good. It plots the S&P’s trailing multiple with the Fed’s data on household equity allocations, the implication being that there’s some predictive relationship between the two series.
“This co-movement between the PE multiple of the US equity market and the equity allocation of the US household sector implies that the higher the appetite by US households to hold equities in their portfolios, the more expensive the equity market becomes and vice versa,” the bank’s Nikolaos Panigirtzoglou wrote.
I’d gently suggest Panigirtzoglou may be overlooking the extent to which those two series are tautologically related.
He also plotted equity fund AUM as % of total fund AUM, which might be a better metric, frankly, although I wonder about it too: Out of all the ETFs created over the past decade, what share were equity-focused? I don’t know the answer to that, but I bet it’s high, and if it is, then that muddles the message.
Panigirtzoglou, describing the chart above, said that “although the peaks in the equity fund share have been rather uniform since the 1990s, the average allocation has been more elevated over the past decade, again pointing to a structural increase in equity allocations since 2015.”
In the course of explaining the allegedly dramatic increase in everyday people’s participation in the US equity market, Panigirtzoglou cited four factors: Free trading (“The emergence of Robinhood in 2014 and its rapid embracing by younger retail investors has transformed US equity trading, with zero commissions incentivizing these younger investors to hold more equities”), COVID (“Quarterly SEC Rule 606 data confirm the large role that retail investors played in propagating the US equity market since the pandemic”), leverage (“[The] NYSE net debit balance suggests individual investors’ leverage in US equity trading has been structurally more elevated over the past decade”) and options, which in Panigirtzoglou’s view have “facilitated the structural increase in equity participation by enabling the more informed retail investors to hedge their equity exposures or adopt more advanced trading strategies.” (They’ve also “facilitated” and “enabled” gambling.)
The overarching message from Panigirtzoglou is that household equity allocations are structurally higher now in the US and retail investor participation more prevalent. That, in turn, “impl[ies] structurally more expensive US equity valuations.”
Suffice to say I agree with the general premise, but I suspect there are better, more trenchant analytical methods for going about proving the point.
Will retail investors be able to keep their faith with the disruptions to the global economy that seem destined to come?
How much of the chart action above is simply a function of rising and falling equity prices?
“Structurally higher” when the structure earnings have been built on is being undermined seems a dubious proposition to me.
“How much of the chart action above is simply a function of rising and falling equity prices?”
I had the same question. Which would coincide with our Dear Leader’s question about correlation vs causality.
But it makes sense that there is something to the idea of a large cohort of retail “investors” increasing use of leverage. It’s not all margin buying, which is tracked. Exhibit one is the explosion in leveraged ETFs, such as 3x NVDA products which has been well-covered here in the context of volatility.
That’s what I meant by: “I’d gently suggest Panigirtzoglou may be overlooking the extent to which those two series are tautologically related.” And also, “I suspect [the chart is] a little too straightforward for its own good.”
I have to be polite about these kinds of things.
There are essentially two types of investors, wealth accumulators and income investors. There are two components to the total return on investment assets. One component is current income and the other is the estimated future growth. With bonds, growth is only guaranteed when the security is purchased at a discount and even then it’s limited. However, for investment grade bonds values and returns are calculable. Outcomes are mostly knowable. I created my investment portfolio by depending on the growth inherent in discount bonds and now live on the steady income cash flow from these instruments.
Wealth accumulators tend to ignore cash income and depend on expected price growth for their wealth accumulation. The thing is the “return” earned in the accumulation phase of equity investing has no certainty attached (Tesla since Nov ’24). The average dividend (cash) return on the S&P 500 is currently 1.311%. All the rest of what talking head pundits call return is not yet realized nor guaranteed. While optimism may abound with the accumulators, the revised value of the market’s assets are only realized then those assets are actually sold. Anyone who has watched their retirement funds disappear can tell one about this issue. We can only spend money we actually receive (Americans are mostly cash basis taxpayers). To become spending cash unrealized gains have to be given up by selling the assets in question, thus giving up all future earnings. What Jaime Diamond and other large banks have discovered is that even when one is mostly concerned with sustainable income, one can still enjoy steady growth, along with growth gained through reinvestment. This century my annual income has grown every year through reinvestment.
Retail equity investors are gamblers who have come to trust that the future will continue in a manner that fulfills their dreams. But the odds are heavily in favor of the fact that the future is a gamble. There are no guarantees that unrealized returns ever get realized until the assets are actually sold.