Are elevated household stock “allocations” a canary?

I put “allocations” in scare quotes because there’s a tendency among some market observers to gloss over the fact that most households aren’t active allocators of capital. Sure, you’ll shuffle things around every now and again (or pay someone to do it for you) to maintain whatever asset mix is appropriate for your age and risk tolerance, or maybe you’ve automated the process somehow, but at any given moment, the share of your total net worth dedicated to, say, stocks, will vary based on equities’ relative performance.

Failing to give due consideration to the impact of market performance on “allocations” can lead to circular reasoning, and also to possibly spurious conclusions. Conclusions like, say, the notion that because household equity allocations sometimes rise in tandem with the index multiple, there must be some causality there when, in fact, the explanation for the correlation is simply that multiple expansion can be coincident with equity rallies which in turn inflate equities as a share of household wealth.

With that in mind — and regular readers will doubtlessly recognize this short piece as an addendum to an article published here on March 20 — I wanted to highlight the chart below, from the Fed’s flow of funds data and also some color from Bloomberg’s Cameron Crise (who’s a smart guy, even as I doubt I’d get along with him).

The figure just shows household stock holdings as a share of total assets. That share, at 29.46%, has now exceeded the Q2 2021 record high.

“[Equity] exposure is comfortably higher than it was at the peak of the dot-com bubble,” Crise wrote Tuesday, on the terminal, before stating the obvious which, as noted above, did need stating: “This simply reflects the impact of market performance more than any conscious asset-allocation decision.”

He drove the point home, somehow without resorting to the sort of snark I would’ve employed. “If you passively own an asset that rises more than 20% in back-to-back years, you’d naturally expect to see it represent a larger proportion of your overall portfolio given there has only been one quarter since 1947 when overall net worth has risen more than 20%.” (Numerators, denominators, math — that kind of stuff.)

As to the question posed here at the outset — i.e., Are elevated household stock “allocations” a canary? — Crise ran the regression. As it turns out, the correlation between equity exposure from the flow of funds release and stock returns over the ensuing 10 years is pretty strong (and unsurprisingly negative). Specifically, Crise’s regression suggests investors should “expect a compounded annual price change for the S&P 500 over the next decade of -1.4%.”

Of course, the reason that figure’s so low is the same reason household equity allocations are so high: The S&P rose 23% in 2024 and 24% the year before that. This isn’t especially complicated, although we have to pretend it is, otherwise a lot of people are out of a job and might have to — you know — do something worthwhile for a living.

I’m generally of the view there’s never a “bad” time to get into the market for someone who’s uninvested and has a reasonably long horizon, but it goes without saying that if you buy at or near record highs, particularly when those records were built atop meaningful valuation expansion, the go-forward asymmetry tends not to be as favorable as it might be if you bought down, say, 15% following a healthy dose of multiple contraction.

Anyway, Crise’s conclusion was that elevated public stock exposure should be considered “a warning, not a signal.” Market participants, he went on, should “be aware of the risks without being overwhelmed by them.”