To me, one of the most striking features of the current US stock-market rally is that many investor sentiments and positioning indicators have stayed depressed, even as equity prices have surged. (Some indicators have risen of late, but the ones I pay the most attention to have not.)
To a degree, the weak sentiment is understandable given the massive blow that COVID-19 delivered to the economy and financial markets. It’s also quite plausible that the recent spike in unemployment could have adverse economic knock-on effects, potentially causing equities to reverse course. On the other hand: 1) we may have reached a nadir in growth; 2) the market itself bottomed seven weeks ago; and 3) the US policy response to the crisis has been swift and aggressive. Perhaps the market won’t retrace its steps backward.
In any event, I would expect sentiment to have improved somewhat by this juncture. Instead, futures positioning and some sentiment indicators (e.g., the AAII Bull-Bear Sentiment Survey)1 have hit new lows amid a roughly 30% stock-market advance thus far. That’s why I’ve dubbed it “the most hated rally in decades.”
Just how rare is this combination from a historical standpoint? Pretty rare. Figure 1 plots S&P 500 Index2 returns (horizontal axis) going back to 1990 against the AAII Bull-Bear (level + change, vertical axis) over the same period. During both the 2000-2003 and the 2008 “bear-market rallies,” sentiment rose sharply just before the rally failed. In contrast, the red square in the chart is where we are now—a complete outlier. It seems to me that with sentiment this poor and policy so loose, a major market pullback in the near term is unlikely.
Investor Sentiment Has Stayed Depressed Even as the Market Has Rallied
Source: Bloomberg. Data as of 5/08/2020. For illustrative purposes only. Past performance does not guarantee future results. Indices are unmanaged and not available for direct investment.
Another unique aspect of this crisis is that it is an engineered economic shutdown. As a result, many investors went from very bullish in January to a sobering recognition that the economy was in serious peril by March, making it easy to get overly bearish on stocks in a hurry. Normally, this takes a year to happen, not a couple months. To have a differentiated negative view going forward, I think you need to believe the longer-term economic impact of COVID-19 will be severe. That could be the case, but I don’t believe we will have any clarity on the long-term outlook for a while, potentially allowing the market to climb a wall of worry in the meantime.
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1 The AAII Bull-Bear Sentiment Survey, hosted by the American Association of Individual Investors, measures the weekly percentage of individual investors who are bullish, bearish, and neutral on the stock market short term.
2 S&P 500 Index is a market capitalization-weighted price index composed of 500 widely held common stocks.
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