A Reading of Advisor Confidence in the Economy and Stock Market

What a difference a year makes. This time last year (March 9, 2009 to be exact), we were in a state of high anxiety—concerned about unemployment, the stability of the banking system, a lack of confidence in the government and financial institutions and the implosion of the stock market. More than one-third of advisors surveyed back then said that it would take investors more than six years to recoup portfolio losses, according to the Advisor Confidence Index (ACI) survey in March 2009. But a year later, we’re seeing a different picture. While some of the same fundamental issues are still at play, the investing community is much more confident about 2010 being a favorable year, with consensus among many leading economists that the world is in the midst of a sustainable economic recovery. According to the Rydex|SGI Advisor Confidence Index—an indicator that reflects advisor sentiment on the market and economy—financial professionals are cautiously optimistic about the stock market and the economy.

Helping advisors take the market’s temperature
Created in 2004 to give advisors a better insight into how their market opinions compared to their peers, the ACI puts advisors “in the know” regarding their counterparts’ economic opinions, according to participating advisors. Having a sense of their peers’ opinions on the market helps advisors recognize if their own outlooks differ greatly or are aligned with those of other advisors—and helps hone their own expectations.

Partially modeled after the Consumer Confidence Index, the ACI captures the sentiments of 150 independent registered investment advisors (RIAs) who complete a monthly survey about their outlook on the economy for various time periods. Each month, participating advisors answer four multiple-choice questions, reflecting their views on the current, six-month and 12-month economic outlook as well as the current stock market. The resulting answers are then encapsulated into a single index number.

If you look at the last 14 months of ACI history and compare it to the stock market (as shown by the S&P 500), you see that advisors’ sentiments usually trended with market performance. However, their outlook never plummeted as far as the market did in late 2009—the correlation coefficient between the ACI and S&P 500 was only 0.2. Perhaps no one wanted to believe things were as bad as they were, or perhaps advisors felt that the market would eventually return to more normalized levels.

Advisor Confidence Index vs. S&P 500

Because the stock market and economic outlook can differ substantially, the ACI tracks both to give an even clearer picture of advisors’ opinions. As Ken Graves of Capital Research Advisors in Alpharetta, Ga., says, “Even though a relationship between the economy and the stock market exists, an assessment of economic and stock market forecasts are not the same. They are not Siamese twins. They are more like second cousins—related, but loosely.” This separation is clear when you look at the ACI economic and stock market outlooks separately. Advisors’ economic outlooks dropped substantially at the beginning of the market crisis in the fall of 2008, even though their stock market outlooks were not as dire. The economic outlook has rebounded substantially from the lows of last summer, although it still trails the stock market outlook, even this year—likely pointing to some of the underlying economic issues that advisors are still concerned about, including unemployment and the budget deficit.

Advisors' Economic and Stock Market Outlook (January 2008-March 2010)

>Utilizing alternative investments for diversification
And while advisors are more optimistic about the stock market, they continue to take steps to enhance diversification in their client portfolios due to the impact of the 2008 market crisis. To achieve their investment goals in today’s volatile market environment, advisors are looking for different investment techniques and including more and more alternative investment products. The potential for alternative strategies is high in this type of environment. There will be many opportunities for alternative asset classes in 2010, and the majority of financial professionals believe that alternative investments will play an increasingly important role in portfolio construction going forward. According to our survey*, most RIAs (81%) believe that traditional asset allocation (stocks, bonds, cash) provides insufficient portfolio diversification. Contrary to popular opinion, financial professionals are not simply looking at alternative investments as a source of outsized performance. The majority of RIAs (81%) cited diversification as the main driver of alternatives usage—only 6% of RIAs see alternatives as high-return, high-risk vehicles.

Alternative investments are becoming more and more mainstream and advisors anticipate a moderate increase in their allocation to alternatives over the next five years. As these vehicles become more widely accepted, we compared firms that offer alternative investments (10% or more of clients’ portfolios) to those that had no alternative investments (alternative investments less than 10% of clients’ portfolios) and found that those firms that use alternatives have more clients and assts under management as do their counterparts.

Alternative Investments and AUM

As you consider the resources available to you as an advisor, don’t discount the value of benchmarking your opinion against those of your peers. Just as baseball coaches utilize stats to gain additional insight on other teams, advisors can utilize information about other advisors—the market outlook of peers and the desire to utilize asset classes such as alternative investments, for instance—to provide them with additional insight on the industry. Combined with their own knowledge, the knowledge gleaned from others helps put these advisors at the top of their game.