Much as we stock market observers love to babble on about valuations, I’ve long been aware that this is largely a futile exercise. My favourite trick is to go Robert Shiller’s stockmarkets data website, and call up the CAPE data for US equities. Hey presto – a shit show! US equities are horribly overpriced. Sell! And if we’re selling the US, we may as well sell everything else.

But this valuation driven perspective ignores a much more obvious truth. Many, arguably most, investors don’t give a damn about valuation. What they care about are expectations and money to burn in their pocket. In other words what drives markets are funds flow (available liquidity) and a yoyo between fear and greed.

This is why I spend a great deal of time staring at fund flows data and why we all collectively display extreme neurosis about what central bankers may or may not do ! Which brings me nicely to current juncture.

It’s very easy to construct an argument which says we are all on the brink of a stockmarket meltdown as the Covid data turns nasty again and all those momentum driven US private investors head for the hills on line. I’m not entirely sure that is the case. Sure, US equities do look more than a tad over priced but that’s a long way from saying that equities overall, as an asset class, are massively over bought.

The most articulate guide I can find through this maze of expectations and liquidity is Cross Border Capital and their latest Global View report is an excellent primer for all investors. The report quite rightly tells us that at the macro level, all the talk about Price to earnings ratios are guff. Better to focus on the power of liquidity and how that translates through to the portfolio level. According to Cross Border “fixed income and forex markets are 80% determined by economic factors (including liquidity) and 20% behavioural factors, such as investors’ risk appetite, whereas for equities this holds vice versa. In short, some four-fifths of what matters in the stock market is investors’ risk appetite”. Which feels about right to me.

The next logical step is to build risk appetite indices and see whether they have any predictive power for subsequent market returns, cross referencing back to uncertainty measures  – and the answer is that they do ! According to Cross Border their “risk appetite indexes precede these uncertainty indexes by 2-3 months and again they are statistically Granger causal…..each one standard deviation downward shift of investors’ portfolios below their ‘normal’ risk settings generates an average 13.7% two-year return for World Equities (equally-weighted)”.

The key is to look at actual portfolio holding’s which is possible for 20 of the major markets on a daily basis. This data reveals that, on average, through most of the period, World investors held a near steady average of 27% in stocks, with a standard deviation of only around 4%, alongside an average of 56% in government bonds and liquid assets, or so-called ‘safe’ assets. From this you then build a simple ratio  between aggregate World equity holdings and Global Liquidity.

According to Cross Border “the current ratio is 0.51 times, or roughly in line with its long-term average. However, importantly the latest reading lies well-below previous peaks of 0.85 times in 2000 and 0.7 times ahead of the 2008/09 GFC. In other words, the data show no evidence of an asset price bubble (my emphasis added)”.

Looking forward this data suggests that “ World equities can still deliver an moderate above-average return over the next two years, with the US likely to provide less support and European and emerging Markets rather more.”

US Investors’ Risk Appetite / Index ‘normal’ range -50 to +50


But for me the key insight is below – UK equities are cheap, remarkably so based on some very obvious uncertainties! The current reading from their index is a low of minus 74 ” which has only been once bested by the lows of the 2008/09 GFC. According to historical experience, UK equities deliver an average two-year ahead returns of 35.5% when risk appetite is at just minus two-standard deviations below normal – each additional standard deviation, in theory, adds another 12% to returns. Figure 10 puts this into context and compares the UK with the World investor average. The differential of minus 45 index points is virtually unprecedented. UK equities are both relatively and absolutely out-of-fashion. Where is Warren Buffett when you need him?