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Does Investor Complacency Signal a Need for Caution?

Investing – 4/7/2017

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Our research consultant, Asset Consulting Group, recently completed an analysis (click here to read) that addresses the growing concern that investors have become complacent. The “complacency index” (bear with us as we delve a little into the weeds here) is an index that is constructed by taking current valuations and dividing them by the market volatility. The higher the number, the higher the degree of “complacency” in the market. As the analysis shows, current levels seem to point to the fact that we are closer to the top of the market cycle than we are the bottom. However, as we’ve seen in the past, the index is not a perfect predictor and certain doom and gloom does not necessarily await us.

In a recent article published in the New York Times, Robert Shiller argued that “caution signals were blinking” for the current bull market. Interestingly though, in making his case, he highlighted the dichotomy of current market expectations. Specifically, he addressed responses to surveys of institutional and individual investors conducted by the Yale School of Management. One of the elements he highlighted was the relative inconsistencies in the responses. On the one hand, his Valuation Confidence Index (the % of respondents who felt valuations were reasonable) was the lowest it has been in the last 15 years. On the other hand, the One-Year Confidence Index (the % of respondents who think the market will go up in the next year) was the highest it has been since 2007. The irony of the latter is not lost on us, given that confidence was highest right before the global financial crisis. However, we believe this inconsistency is less an indictment of the respondents’ investment acumen and more a reflection of the fact that bear markets are usually triggered by shock events, which by definition are difficult to predict.

Ultimately, is it possible that we see a correction or even a bear market? Most certainly. In fact, for long-term investors, corrections and bear markets are about as certain as death and taxes.  However, our investment advice stems from the perspective that we will be investors over numerous market cycles and that your goals must be achieved in spite of the natural ups and downs. We can’t avoid them and we can’t predict them, but we will manage around them.  To that end, we think using data points such as the ones provided in the attached analysis serve as good reality checks. They inform our expectations and decisions as we look ahead.

Sincerely, Matter Investment Committee

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