FINANCIAL MARKET UPDATE 4.28.2020

STORY OF THE WEEK

INVESTOR SENTIMENT JUST HIT THE LOWEST LEVEL OF THE YEAR

Every Thursday, the American Institute of Individual Investors (AAII) publishes a widely followed sentiment survey. The publication shows how mom and pop investors feel about the short-term prospects of the stock market. While not always meaningful, when the gauge hits an extreme, it’s often an accurate indicator of where things are headed.

The survey began in the late 1980s and is often used by professional investors trying to take the temperature of the market. It asks a simple question: “I feel that the direction of the stock market over the next six months will be…?”

  1. Up (Bullish)
  2. No Change (Neutral)
  3. Down (Bearish)

The results from the most recent survey show that half of the respondents are expecting the market to be down over the next six months. This marks a large shift toward bearish sentiment from the previous week.

You can get a sense of how bullish (optimistic) or bearish (pessimistic) investors are in general simply by looking at the relative spread between the two groups. Based on the chart above, historically, 38% of respondents fall in the bullish camp on average, while 30.5% fall in the bearish camp. This suggests investors as a whole are generally optimistic, as there are 7.5% more bullish investors on average. The chart below illustrates the spread over the past few years, and provides some context to last week’s unusually bearish reading of -25.1%.

Source: Sentiment from American Institute of Individual Investors, Returns from Morningstar Direct. 1/3/2013 – 4/24/2020.

How well have our faithful survey takers predicted near-term market moves in the past?  Not well! When comparing the historical survey results since the 1980s to actual market returns, a few patterns emerge:

  1. Investor sentiment typically reflects what has just happened. High pessimism typically followed periods where the market had negative performance, while high optimism followed periods where the market had above-average performance.
  2. When sentiment hits an extreme level, the market tends to reverse. Excessive pessimism has often been followed by above-average returns, while excessive optimism is typically followed by below-average returns.

Investor Sentiment versus Market Returns

Source: Sentiment from American Institute of Individual Investors, Returns from Morningstar Direct. 12/31/1987 – 4/24/2020. Returns are not annualized. Three month periods are estimated based on survey release dates (weekly). 

Historically, when investors are as bearish as the most recent report revealed, the market has generated above-average returns in the near-term. To some degree, this seems to already be playing out, as the S&P 500 has gained 2.9% in the two days since the report was published. The strong performance over the past two days is part of a broader rally that has seen the index gain 28.7% off the March lows. While this is certainly a welcome development, it has generated fear that it may be too much too fast. Nobody knows whether we are in a sustained recovery, or if we will eventually retest the lows. Although much of the recent news flow has been negative, I see low investor sentiment as a positive sign for the market.

WEEK IN REVIEW

  • Last Friday, a new $484 billion coronavirus relief bill was signed into law. The bill includes an additional round of funding for small businesses totaling $370 billion, hospitals will receive $75 billion, and $25 billion will be earmarked to help ramp up COVID-19 testing. There was some indication that an additional bill would be passed to assist states and municipalities.
  • According to data from Factset, about 24% of the S&P 500 have reported earnings for Q1 thus far. If you blended the results from those companies that have reported, with the estimates for those companies that are still due to report, the blended earnings growth would be -15.8%. That represents a deterioration from -14.8% the prior week.
  • Highlights for the week ahead include the conclusion of the next Federal Reserve meeting and the publication of the initial 1st quarter GDP estimates. No major monetary policy changes are expected to be announced following the Fed meeting on Wednesday, but investors will be looking for hints regarding future actions, including how long they plan to hold the benchmark interest rate near zero. According to the Wall Street Journal, economists are expecting a 3.5% decline in GDP during the 1st quarter, which would mark the first quarterly contraction since 2014 and the largest since 2009. Economists are expecting a substantially larger decline in Q2, as much of the coronavirus related shutdowns did not occur until very late in the 1st quarter.

HOT READS

Markets

  • Markets Diverge in Assessing the Economic Freeze (WSJ)
  • Trump Signs $484 Billion Coronavirus Relief Bill to Boost Small Business, Hospitals and Testing (CNBC)
  • The Federal Reserve is Changing What It Means to Be a Central Bank (WSJ)

Investing

  • As If (Humble Dollar) Ignore the media’s explanation of daily market moves
  • What’s the Worst Case Scenario for Diversified Portfolios (AWOCS)
  • When Your Fund Beats the Market, Ask: Which market? (Zweig)

Other

  • Charlie Munger Will Not Take Questions at Berkshire Hathaway’s Annual Meeting This Year (CNBC)
  • This Famous Poker Player Can Help Investors Play a Tough Hand (Barron’s)

ECONOMIC CALENDAR

Source: MarketWatch

MARKETS AT A GLANCE

Source: Morningstar Direct.

Source: Morningstar Direct.

Source: Treasury.gov

Source: Treasury.gov

Source: FRED Database & ICE Benchmark Administration Limited (IBA)

Source: FRED Database & ICE Benchmark Administration Limited (IBA)

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ABOUT THE AUTHOR

402.763.2967

jjenkins@lutz.us

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JOSH JENKINS, CFA + SENIOR PORTFOLIO MANAGER & HEAD OF RESEARCH

Josh Jenkins is a Senior Portfolio Manager & Head of Research at Lutz Financial with over nine years of investment experience. He is responsible for assisting clients in the construction, selection, and risk assessment of their investment portfolios. In addition, Josh will provide on-going research and trade support.

AREAS OF FOCUS
  • Asset Allocation & Portfolio Management
  • Investment & Market Research
  • Trading
AFFILIATIONS AND CREDENTIALS
  • Chartered Financial Analyst (CFA)
  • Chartered Financial Analyst Institute, Member
  • Chartered Financial Analyst Society of Nebraska, Member
EDUCATIONAL BACKGROUND
  • BSBA, University of Nebraska, Lincoln, NE

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