The latest victim of the raging bull in stocks is Wall Street’s maxim that glowing investor sentiment is a sell-signal.
Throughout 2021, a series of surveys, fund flow metrics, and option activity have shown that investors large and small are exceptionally optimistic. Still, major US indices continue to rebound to record highs, adding a healthy 13% to the Dow Jones Industrial Average for 2021.
Analysts have long relied on sentiment and related risk appetite data as contradicting indicators. When friends, co-workers, and strangers invest money in stocks and tell you about it, it is time to take cover for that mindset. Likewise, if everyone is selling, buy with both hands.
But for much of this year staying with the herd has paid off tremendously. It is the latest departure from the tried and tested in a year that has seen soaring meme stocks, record wood prices and a rally in bond markets in the face of soaring inflation. In short, analysts and portfolio managers are now wondering if this time around is really any different.
“We’ve been throwing our hands up for a while,” said Jason Goepfert, president of Sundial Capital Research. “Whatever the reason, the market is just overrunning all of these historical indicators that previously had a very consistent track record.”
Over the coming week, dealers will be analyzing data on construction starts and permits, and revenue from companies like Johnson & Johnson and United Airlines Holdings Inc.,
for further information on price pressure.
You will also watch to see if the mood fluctuates. Recently, some indicators have shown signs of weakening sentiment, although the bull market remains broadly above or near the long-term average.
American stock allocation reached nearly 60% in late March, just below the all-time high of 61.7% reached during the dot-com bubble, according to 1951 data from Ned Davis Research.
A July poll by retail broker E * Trade found that the bull market among the platform’s individual investors recently hit more than a three-year high, rising to 65%. In addition, the often-observed put-call ratio of stocks – which measures the volume of bearish option bets on stocks versus bullish ones – saw a sustained optimism earlier this year that has not been seen since 2000.
The source of the optimism that fueled 39 records in the S&P 500 this year is not difficult to guess. Most importantly, there is an unusual and powerful mix of stimulus and loose monetary policy that has flooded investors with liquidity and few sources of stable investment returns. The arrival of a new cohort of retailers has also given prices an additional boost.
Analysts say the combination of these factors has propelled markets higher, giving traders enough momentum and opportunity to ignore signs of tense sentiment – as well as other risks, including unclear inflation outlook and rising coronavirus cases.
Recently, market breadth, or a measure of how many stocks are rallying, has deteriorated – although major indices have continued to hit all-time highs.
As of Thursday, only about 49% of stocks in the S&P 500 were trading above their 50-day moving averages, according to FactSet, a level that is below average and a sharp reversal from a few months ago when that metric hit above 90%. According to Liz Ann Sonders, chief investment strategist at Charles Schwab, this is a worrying sign if sentiment stays this high.
“Every long-time mood observer knows that width is a positive compensation for extreme mood conditions,” said Ms. Sonders. “But when the breadth starts to deteriorate and the market is still trading at or near all-time highs and sentiment has not deteriorated, then real trouble is brewing.”
But sentiment can stay elevated for long periods of time, as it did in the late 1990s, she said. And while the major indices have risen, surpluses have lost momentum.
“In places where speculation was rampant, there have been massive declines – in cryptocurrencies, [special-purpose acquisition companies], unprofitable tech companies and meme stocks, ”said Ms. Sonders.
According to a recent release from Charles Schwab, based on data from Ned Davis Research, the S&P 500 averaged modest returns in the years that followed when US household stocks hit one of the highest levels previously. For example, if the household equity allocation rose to 54.6% or more – as it did during the dot-com bubble and in the years before the 2007-09 recession – the average annualized return on the S&P 500 over the next 10 years was 4, 1%
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Conversely, when the equity allocation fluctuated 29% or less, the average annualized return on the benchmark index over the next 10 years was 16.3%.
Still, the unique market conditions this year could allow stocks to slide further.
“The markets just do their own thing,” said Goepfert. “Something has changed. Be it unprecedented impetus or maybe there is this generation change among young investors. This new surge in the market is driving stocks higher.”
Write to Caitlin McCabe at caitlin.mccabe@wsj.com
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source https://thedailytradingnews.com/record-stock-rally-ignores-wall-streets-phobia-about-optimism/
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