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This Overlooked Number Could Determine Whether Any Market Correction Turns into a Crash

2 | By Shah Gilani

Of all the data in the just-issued Federal Reserve Statistical Release Z.1: Financial Accounts of the United States Q2 report, the fact that households and non-profits have 35.7% of their total financial assets in stocks was most surprising.

That’s the second highest percentage of stock holding for households on record, compared to the high of 42% in 2007, just before markets crashed.

Watching the percentage of households’ financial assets parked in stocks increase this late in “The Most Hated Bull Market in History” is important for two reasons.

It’s either telling us that the end is near, or that this time is different.

Here’s how you’ll know…

What Slaughters Bull Markets

The percentage of stocks held by households hasn’t been a consistent leading indicator of the market’s future direction. However, high percentage spikes in 1968, 1972, 2000, and 2007 were followed by market routs.

But, to be clear, the high percentage of the value of stocks held relative to other household financial assets is not what caused markets to correct or crash. Deteriorating economic conditions, irrational exuberance, and egregious leveraged speculation kills bull markets.

The fact that large numbers of households hold stocks that lose value, that then begets selling upon selling, only adds to downturns and sets lower bars from which holdings increase again in bull markets.

The truth is that there are two ways household holdings can increase; one simple, and one more complicated.

  1. Households increase their holdings by simply adding to their portfolios.
  2. The increase as a percent of total financial assets results from rising markets that pump up the value of stocks, relative to other portfolio assets like real estate.

At this late stage in the eight-year unloved bull market, households are increasingly coming off the sidelines, adding to their holdings, and benefiting from the huge run-up in stock prices.

But they’re still scared.

That’s why knowing the percentage of households that are watching their financial net worth increase with the rising market is so important.

A market moving event could turn stocks around and send them lower. Or, for the first time in history, households could turn the narrative on its head.

This time it’s possible that households – scared of how much they have in this bull market, with fresh memories of the 2008 crash and lingering memories of the 200 tech wreck – sell their holdings and become the straw that breaks the market’s back.

This Time, History Might Not Repeat Itself

Households have a lot at stake in the market.

According to the Fed’s Z.1 Release, the value of U.S. equities jumped a nominal $1.50 trillion during the second quarter of 2017 to a record $42.23 trillion

Over the past four quarters, U.S. equities have jumped $6.182 trillion in value, or 17.1%. To put that stellar rise in some perspective, the value of stocks rose $3.9 trillion in the 1999 bull market and $3.5 trillion in the strong 2006 market.

This year, the value of equities at the end of the second quarter was 67% higher than at the close of 2007. Another staggering percentage is the total value of U.S. listed equities, which ended the second quarter of 2017 at a record 219% of GDP.

What’s scary is how eerily similar this is to when stocks had cycle peaks of 181% of GDP during the third quarter of 2007, and 202% of GDP at the end of the first quarter of 2000. Both of these periods coincided with high percentages of household ownership that led to market crashes.

Investors and households are justifiably nervous.

Of course, there are strong reasons that this time could be different.

There are a lot fewer listed companies these days and a lot fewer shares outstanding. That means long-term investors (like institutions, pension funds, and retirement account investors who tend to be buy-and-hold types that have a lot of shares parked safely) aren’t going to run too quickly if any selloff turns into a correction.

The new and fast-growing crowd of passive investors are essentially buy-and-hold index investors who’ve been taught to own the market because it always goes higher. They are not likely to lead any charge out of stocks.

Markets have a lot of positive momentum behind them, along with a lot of nervous, still-sidelined investors waiting for a correction to get in. That’s a lot of buying powder at the ready.

Things could be different for a while. The percentage of household assets in stocks could keep increasing for years to come. Households could be the drivers of the markets next big, multi-year leg up.

Or, they could run for the exits, taking their chips off the table and knocking the market down in the process.

I’ll be keeping an eye on the percentage of households’ financial assets parked in stocks increasing or decreasing in “the most hated bull market in history.” That number could determine an enormous amount of the market’s future. And, if there’s any change worth noting, I’ll be sharing it with you all right away.

Sincerely,

Shah

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