One of the primary arguments coming out of the bear camp these days is the stock market game is just too easy right now. Our furry friends suggest that when things become too one-sided for an extended length of time (such as this being the longest period in history without a 3% correction), the tide can quickly turn.
The focal point to this argument has to do with investor sentiment. And based on the indicators I review on a regular basis, sentiment has indeed reached bullish extremes. For example, the reading of one crowd sentiment model I follow currently stands at 73.5. Although the model reading has been near this level twice already this year, it is important to note that (a) this week's reading is the highest of the year and (b) in the last fifteen years, there have only been two readings that were higher.
Another example that this market is beginning to be "loved" instead of "hated" is the level of margin debt investors hold. According to the Wall Street Journal, investors held $559.6 billion in margin debt at the end of September. This level is a record high (the 7th such record set this year) and is up 14% from the end of 2016. As the Journal points out, higher levels of margin debt can be seen as a measure of confidence in the current market.
Next up is the confidence level of newsletter writers. While I can certainly argue that the newsletter game has experienced a meaningful decline over that last decade, analyzing the spread between bullish and bearish writers still has value in the sentiment department. As of last Wednesday, Investors Intelligence reports that 64% of newsletter writers were currently bullish while just 14% were bearish.
The folks at Investors Intelligence tell us that sentiment risk become "elevated" when the spread between the number of bullish and bearish newsletter writers exceeds 40%. Point number one here is that this spread has now exceeded 40% for six straight weeks. Point number two is that last week's spread between bulls and bears was the highest in more than 30 years.
Then there is the subject of stock market volatility - as in the lack thereof. On that score, according to The Wall Street Journal's Market Data Group, it has been 45 days since the S&P 500 last had so much as a 0.5% decline, which is the longest such streak since 1968.
As we've noted previously, the current low volatility environment, while not unprecedented, is fairly unusual. If memory serves, volatility has only been this low in the late-1990's and the mid-1960's.
Consumer sentiment towards the economy has also been improving steadily this year. The reason I bring this up is that consumer sentiment tends to be correlated to the movement in the stock market. In short, when stocks go up, consumers become more comfortable with their financial positions and vice versa.
So, it is interesting to note that the University of Michigan's gauge of consumer sentiment climbed to its highest level since 2004 last month and a Conference Board indicator was at its highest reading since 2000 in October.
I could go on, but the big point this morning is that investors appear to be in their happy places right now when it comes to the stock market.
Over the years, I've learned that when investor sentiment reaches extreme levels, it means they are usually pretty well invested. You see, the public doesn't invest when things are scary (and prices are low). No, they tend to wait until things "feel good" before putting their money to work. So, by the time extreme readings show up in the sentiment models, most of the money has already been invested.
The key is that if investors are happy (they are) and mutual fund cash is low (it is), then a great deal of buying power has already been used up. This means that the market can experience a vacuum of demand if things turn south. As such, I can argue that risk becomes elevated alongside extremely positive sentiment readings.
As the saying goes, the public tends to be wrong at both ends of a move but right during the middle of the trend. So, with folks feeling pretty good right about now, it might be a good idea to recognize that an uptick in volatility could begin at any time and for just about any reason.
But, with the fundamental models still in good shape, the game plan remains the same for now - buy the dips. Assuming there are any dips to buy, that is.
Thought For The Day:
Judge a man by his questions rather than by his answers. -Voltaire
Current Market Drivers
We strive to identify the driving forces behind the market action on a daily basis. The thinking is that if we can understand why stocks are doing what they are doing on a short-term basis; we are not likely to be surprised/blind-sided by a big move. Listed below are what we believe to be the driving forces of the current market (Listed in order of importance).
1. The State of Tax Reform
2. The State of the Earnings Season
3. The State of Fed Policy/Leadership
4. The State of the Economy
Wishing you green screens and all the best for a great day,
David D. Moenning
Chief Investment Officer
Sowell Management Services
Disclosure: At the time of publication, Mr. Moenning and/or Sowell Management Services held long positions in the following securities mentioned: none. Note that positions may change at any time.
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