Threats of nuclear war. Powerful storms rolling in from the sea to batter American cities. Political division and legislative gridlock. The news headlines don’t provide much food for optimism these days. You might not guess that from looking at the stock market, though.
Despite giving up some ground in recent days, the S&P 500® Index is still not far off the record high set earlier in September. So what’s going on here?
If anything, the apparent disconnect between the gloom of the news and the resilient buoyancy of the stock ticker is a reminder that the stock market isn’t mechanistic. There’s no law that says bad news from the real world will automatically show up in stock prices.
But it is still worth taking a moment to consider the sources of the stock market’s high spirits and what they might mean. In particular, measures of investor sentiment can provide insights into what’s driving the market’s performance. Here, a more nuanced picture emerges.
Before checking out the survey data, it makes sense first to step back and consider the stock market’s recent strength in context. The optimist’s story starts here.
The current bull market in stocks is now well into its ninth year and shows few signs of stopping (though the prospects for volatility may be growing). The stock market has touched a series of record highs this year as it has notched a relatively steady recent record of small percentage gains. Economic growth remains steady, unemployment is low and the Federal Reserve—which appears to be confident enough in the economy to have begun withdrawing the monetary support it unleashed to fight the financial crisis—expects inflation to start picking up later this year.
Corporate earnings both at home and abroad have brought this economic strength home to investors and helped drive the market higher.
Attitudes and behavior
A variety of measures and surveys allow us to get a sense of what investors actually make of these developments. We can break these down into attitudinal measures—which capture what survey respondents say they feel about the market’s performance—and behavioral measures—which capture what investors actually do.
The results are interesting.
“Investors’ attitudes are more muted than their behaviors,” says Schwab Chief Investment Strategist Liz Ann Sonders. “The former appears to be related to the storm of uncertainty swirling around.”
She notes that Ned Davis Research’s Crowd Sentiment Poll shows that although the survey’s headline number shows sentiment hovering in “extreme optimism” territory (which historically hasn’t been a great sign for returns), several of its sub-components show that optimism among certain segments of the investing public is more muted than you might expect. For example, investment newsletter writers are less optimistic now than they have been in recent months, while individual investors, though still bullish on the stock market, are less so than they were at the start of the year.
But so far the relative softening in sentiment hasn’t appeared to change behavior. For example, Fed data show that households’ stock holdings are now at the their second highest point on record, and a survey by the National Association of Active Investment Managers found that professional money managers are also heavily invested in stocks right now. It has been 12 weeks since any manager has been net short stocks—the longest stretch in the survey’s 15-year history.
“I also keep a close eye on SentimenTrader’s ‘Smart Money’ and ‘Dumb Money’ Confidence indexes, because they can quickly tell you what the ‘good’ market timers are doing with their money compared to what ‘bad’ market timers are doing,” says Liz Ann. “What’s interesting is that these two groups are now moving in opposite directions: The Smart Money index has been getting more pessimistic, while the Dumb Money has been chasing stocks higher and has become more optimistic.”
“We’re not at extremes yet, but the situation is worth watching,” she says. “All things considered, low volatility and the elevated equity exposure we saw from the behavioral measures suggest the market may be a bit too complacent.’
How to respond
Observers could be forgiven for thinking this is a bit of a conundrum. On one hand, the economic fundamentals look broadly favorable and the market is still fairly upbeat. On the other, it’s worth wondering how long the high spirits can last.
“Time and the steady march higher by stocks have eased the painful muscle memory of the financial crisis and subsequent bear market. I think the next bear market remains in the distance and will likely come only if it’s sniffing out the next recession and/or if monetary policy becomes much tighter,” says Liz Ann. “But I wouldn’t mind some fiercer pullbacks to keep excessively optimistic sentiment at bay.”
It’s also important to remember that it’s incredibly difficult to say when the market might face its next rough patch. That’s why we encourage investors try to take the long view and keep their portfolios diversified across stocks, bonds, cash investments and other assets in accordance with their risk tolerance and investing timeline.
Rebalancing is also a key part of good investing hygiene. Market changes can skew your asset allocation over time, as investments that gain in value will become a larger part of your portfolio while declining investments will shrink relative to the rest of your holdings. Periodic rebalancing can help ensure that your portfolio still reflects your target allocation.
What you can do next
Don’t try to time the market—it’s time in the market that counts. Want to talk about your portfolio? Call our investment professionals at 800-355-2162.
Watch Schwab experts discuss other market and economic topics in the Schwab Market Snapshot.