LIZ ANN SONDERS: Hi, everybody. Welcome to the July Market Snapshot.
As you know, I sometimes will tackle economic stories. I’ll sometimes tackle market stories. Sometimes it’s very big picture. Sometimes it’s a bit narrow. I want to blend the economy and the market, but in the context of a discussion about sentiment. As those who have read my reports, have seen these videos, I do focus a lot on sentiment as it relates to both the market and the economy. And in this episode, I want to look at the combination of both, and take a look back into history to see how the sentiment conditions that exist now, what they’ve meant for market behavior in the past.
So the first one I want to start with is actually consumer confidence. So we’re now looking at sentiment on the economic side of the picture, not so much on the market side of the picture, but I want to tie it into market behavior. So the chart here is a simple look back to the late 1960s of the measure of consumer confidence tracked by the Confidence Board. It’s a monthly reading, there is one headline index, which is shown here, and the gray bars, not just on this chart, but any other chart that you see gray bars, those represent recessions officially. And the reason why we have that gray bar at the most recent period of time extending out to the present is because, as most people know, there has been no yet official declaration of the end of the COVID recession. So, for now, it’s still officially in recession territory. And you can see, obviously, that confidence ebbs and flows, tends to deteriorate, certainly, in the beginning part of a recession, usually bottoms around the end of a recession, and then starts to move up. So the pattern that we’ve seen is not inconsistent with what we’ve seen in the past. That said, the trough in consumer confidence was quite a bit higher than what you typically have seen in recessions. And that had a lot to do with just the massive amount of stimulus and fiscal support that came in that I think buffered that consumer confidence.
So we’re now on the way back up, not quite yet back to where we were at the highs before the COVID recession. But take a look down below. This may be a bit counterintuitive, but it’s in keeping with investor sentiment when it gets stretched toward optimism, toward extreme optimism. Historically, the market has had a bit more of a struggle. And that actually can be applied even to economic sentiment measures. So you can see three broad zones here for consumer confidence. And that higher zone is when confidence is above 106, which clearly we are right now, and you can see the annualized returns for the S&P 500 during those periods. We’re not looking at deep negative returns, by any means, but low single-digit returns, certainly, worse returns, interestingly, than when confidence is low, because we have to remember the stock market is a leading indicator, it tends to move in anticipation of the improvement in metrics like this.
We can also look at components of consumer confidence. Within the survey that’s done on a monthly basis not only are the surveyors, the Confidence Board, asking a simple question about ‘How’s your confidence?’ but then they have sub questions that ask about ‘How do you feel right now?’ That’s the present situation. ‘How do you think you’re going to feel in six months? What is your outlook six months from now?’ And that’s the expectations component.
So unlike during the pandemic, when you saw… during the pandemic recession, you saw that big spike up in the spread between those two, that reflected a period of time where consumers were saying, ‘Boy, I don’t feel great right now, but my guess is, given stimulus, given that we’ll come out of this eventually, I’m going to feel much better down the road.’ The opposite is now happening in the more recent period of time. As that line has moved down, we’ve moved into negative territory. That reflects that consumers are saying, ‘I feel pretty good right now, but I’m a bit worried about down the road.’ So the expectations component is what has deteriorated. You can see that when you get down to low levels in that spread, and then you start to move back up, that actually is indicative, historically, of a recession coming.
Now, this is a very, very unique period of time, obviously, especially given that we don’t even yet have the declared end of the recession, so I think it’s well too soon to say we’re facing economic trouble here, but this is something definitely worth watching because we’re seeing that deterioration in forward-looking confidence relative to the confidence we feel right now.
We can also, now, start to transition into the investor side of the equation by looking at CEO confidence, which is typically directly correlated to corporate profitability, which if you’ve paying any attention to the earnings environment, earnings are absolutely on fire right now. Second quarter earnings for the S&P 500 are expected to be up nearly 70% on a year-over-year basis. And that is reflected in very high confidence on the part of CEOs.
Now, this confidence measure also put out by the Conference Board, doesn’t have as long a history as their consumer confidence measure. This goes back to the mid-1970s, but, again, you can see the ebbing and flowing of this. And you can also see that this recent surge in CEO confidence is to an all-time record high in the history of this data. Again, on the surface that would seem to be a great background condition for the stock market, given that CEOs are running the companies behind the stocks that drive the stock market. But as you can see down below and keeping with the stock market, generally pricing in a lot of what we’re now just starting to see in things like earnings and confidence, the market is actually had lower annualized returns when confidence is in its highest zones versus in its lowest zones. And I don’t think it is a stretch to say that a lot of the good news that we’re in the midst of seeing right now has arguably been priced into stocks, given the stellar performance we’ve seen over the last year or so.
Now I want to shift to actual investor confidence measures. And I always think about sediment from an investor perspective as having two buckets, there are sediment indicators that are attitudinal in nature, survey type data, where you’re basically asking investors, ‘What do you think about the market? Are you bullish or bearish?’ And then there are behavioral measures, tracking what investors are actually doing, what their positioning is. And I tend to focus a little bit more on those behavioral measures because it’s actual real money gauges. And this is one of the broadest measures we can look at. It’s a fairly simple one, but I think an important one as we think longer term looking ahead.
So this is overall exposure to equities by all US households. It comes from FactSet data combined with Federal Reserve data, and you can see, and it’s the blue line we’re talking about initially here, that we are up at about 60% in terms of the overall exposure to the equity market that US households have right now. That’s not quite to the same extreme as what we saw back in 1999, but certainly getting close. And there’s nothing to prevent this from continuing to go up. We’re not here to say, okay, it’s now peaked like it did in 1999 and about to come down.
But what it does potentially give you a signal of is what the next decade is likely to look like from a returns perspective, and that’s what the yellow line shows. It’s the subsequent 10-year return for the S&P 500. And that’s why the line doesn’t carry fully through to the end of this period because, quite frankly, we don’t know what the next 10 years is going to look like. So that’s why the yellow line stops 10 years prior.
To put it in clear context, you can look at the table down below and it breaks that blue line, that household equity exposure into quintiles, into 20 percentage point buckets. And you can see, we are clearly in the highest quintile based on history, and you can see what the average allocation was in each of those quintiles. And then that far right column shows the average annualized return over the subsequent 10-year period of time. And then the two columns that precede that just show the range, the lowest return, the highest return, again, over to that average. And much as with some of these other sentiment indicators that I already discussed, we’re not talking about negative returns, Armageddon-like returns, but certainly more limited returns than you typically get when you’re in that lowest quintile of household exposure. Think about the late 1980s, right into 1990, the setup for what was the unbelievable boom-bull market of the 1990s. That set up was somewhat a function of equity exposure having been quite low. So that fuel for additional gains was much more significant than during a period where exposure is high. So just something to keep in mind and maybe a bit of a caution about extrapolating the kind of returns that we’ve seen in the last year and a half or so too far into the future.
Another very interesting and very popular chart, every time I show it, be it in a report, or on a video like this, or on Twitter is put together by actually friends of mine in the business, a great research partnership of ours, with a company called SentimenTrader. And they track real money gauges for two particular cohorts. Now, these are their names, not our terminology, this is SentimenTrader’s terminology. And they label the cohorts the so-called smart money and the dumb money. And the dumb money is not really in specific reference to individual investors or retail traders, but they’re looking at odd lot much smaller positions, speculators in the equity-only options market, some of the movement in and out of some of the mutual funds, bull and bear mutual funds that are heavily focused on by shorter-term traders. And then the so-called smart money are the big commercial hedgers, the big position traders, the big speculators in the index futures market. So very different cohorts. And what they found is at extremes, the smart money tends to be pretty accurate and the dumb money tends to be less accurate, and, in particular, when you get to a very widespread between the two of them.
In fact, if you look back to just about above the middle of that 2020 marker, on the bottom there, where you see dumb money confidence at an extreme high and smart money confidence at an extreme low, that was just prior to the pandemic bear market that started in February of last year. So that was sort of a perfect setup based on these metrics. Then by virtue of the bear market that unfolded, you see those two moved in the complete opposite direction. And in that late March timeframe, you had the perfect sort of opposite setup where smart money confidence had surged and their positioning had surged to the bullish side, while the dumb money was reacting to what had been a very brutal albeit short bear market. And then you see we’ve seen some waffling along.
What’s most interesting maybe about the 2021 period until recently, the first several months, anyway, is the dumb money was actually right. Their positioning stayed very positive, very bullish, and that was actually right. And more recently, the smart money hasn’t been quite so accurate, and they’ve been scrambling a little bit to move up to a more optimistic positioning, and you can see the two are close to converging.
So this isn’t a perfect indicator by any means, but if we continue to see that dumb money confidence come down and smart money confidence go up, this would actually be one of those sentiment indicators that is not a negative potential signal for the market.
So I just wanted to… even though it’s not an extreme right now, it’s such a popular pair of metrics that I show, I wanted to bring that into this sentiment look.
Now, we’ve also got something called a panic euphoria model. Citigroup pioneered this many, many years ago, but they’re proprietary in terms of how they construct this model. So, again, our friends at SentimenTrader decided to try to reconstruct their model and put it together in a way that was a bit more transparent. They can provide us with the background data and we can put it together like you see here. And it really is a cross-spectrum of indicators that span not just the investor side of panic or euphoria, but also brings in some economic type sentiment measures similar to what we showed with consumer confidence and CEO confidence. So there’s some Wall Street and Main Street components to this panic euphoria.
And you can see just a couple of months ago, we hit an all-time high of euphoria as measured by a model like this. And this was really one of those warning signs that even if not a significant bout of weakness to come, probably more volatility. And, quite frankly, where we have seen a lot of that real speculative excess in some of the non-traditional pockets of the market, be it in cryptocurrencies, or SPACs, or the meme stocks, or heavily-shorted stocks, non-profitable tech stocks, most of those segments are down anywhere from 30-, 40-, 50% from their recent highs. So we’ve seen some of this speculative fervor wane a bit. The good news is it hasn’t been as concentrated in the traditional market averages. And that’s why we haven’t seen the same pain.
So we’re seeing a little bit less euphoria, and it’s manifested itself in weakness in these non-traditional areas. But the good news is that that heightened speculation has been less evident in the traditional market, which so far is I think good news for investors more broadly.
Where we are seeing a big pickup recently are flows into equity ETFs. And this ties back to that household equity exposure chart that I showed. What was interesting about the recent surge in household exposure to equities is that only recently have we seen fund flows pick up. You can see for several years, 2017, 2018, even into the beginning of 2019, we were actually seeing a move down in fund flows. Yet that household equity exposure continued to go up. What that reflected is that investors were not rebalancing that much. They were letting their equity holdings expand as a share of their overall assets because they weren’t trimming them back. They weren’t taking profits. And you’ve added to that recently by flows actually picking up. So this is, again, a behavioral measure of sentiment that hadn’t been tracking some of the euphoria that we were seeing in other sentiment measures, but, certainly, the very recent period has kicked that into higher gear, and, again, something we need to keep a watch on because at past highs, that has not been an overly positive signal for the market.
Wrapping it all together is a crowd sentiment poll that my friends at Ned Davis Research... I’ve known Ned, himself, since the mid-1980s when I started in this business, and he does some unbelievable work on sentiment, and we do a lot of research sharing together. This is a crowd sentiment poll that he has been keeping for decades, and it’s an amalgamation of seven separate sentiment indicators, all of which are widely tracked by pundits, and investors, and economists. And it’s a nice consolidated wrap it all up way to look at sentiment broadly. There’s behavioral measures in here. There’s attitudinal measures in here. And you can see, although down a little bit recently, we are in the extreme optimism zone in terms of sentiment, which, generally, is a contrarian indicator for the market. You can see that in the table below. The zone we’re in right now, where sentiment is at its most optimistic, actually, the market has had slight negative annualized returns. And that’s just something to be mindful of.
I’ll conclude, though, by saying that sentiment, in and of itself, is not a very good timing tool. It doesn’t tell you that a move by the market in a contrarian fashion is going to happen imminently. It just says that the risk is a bit higher, especially if you get some sort of negative catalyst. Last year, as I talked about, that negative catalyst was the virus. Talk about the mother of all catalysts. We don’t really have a negative catalyst right now. Inflation, I think, represented a bit of one earlier this year. We did get a 10% correction in the NASDAQ when we had that first spike in yields in anticipation of the inflation we’re seeing right now. I would put maybe a monetary policy mistake as a possibility. And then the fact that market breadth has been deteriorating a little bit, that positive market breadth tends to serve as a positive offset to sentiment. That’s less so now. So this is more of a message to just be on watch. Because sentiment is generally skewed toward the extreme bullish end of the spectrum, that just sets up the possibility for maybe a bit of weakness, a bit of volatility, to the extent we get some sort of negative catalyst.
Thanks, as always, for tuning in. I hope you enjoyed this report.