In our last post, we shared a different perspective on viewing future stock market returns (vs. the traditional approach of using valuation levels) introduced by the author of the Philosophical Economics blog several years ago. As a reminder, the basic premise was to take a supply/demand perspective on equity, fixed income and cash allocations using several data points from the Federal Reserve’s Flow of Funds report, which was released for 4Q18 yesterday.
Not surprisingly, the average investor equity allocation ticked down meaningfully in 4Q18 after the beating the equity markets took. Fixed income markets didn’t fare greatly in the fourth quarter either but their drawdowns were naturally much less severe. As we mentioned previously, average equity allocations were at their second highest level in this data set at the end of 3Q18. At the end of 4Q18, they were below last cycle’s peak but still elevated relative to history. Maybe 3Q18 was this cycle’s peak as some have suggested but maybe the peak for this cycle is still to come. Who knows? It will be interesting to see how much equity allocations bounce back after a fairly robust start to 2019.