From the Desk of Willie Delwiche

Investors had second thoughts about stocks last week, with sentiment dropping across the board. This week’s Investors Intelligence survey shows a healthy return to optimism as bears dropped to their lowest level in over a year and the bull-bear spread moved back above its August high.   

Why It Matters: Stocks tend to do well when persistent pessimism fades. In such an environment increasing investor optimism is a bullish tailwind for stocks. The shift from pessimism to optimism is not always a one-way street. Consolidation along the way is to be expected but a return to ex excessive pessimism would not be a healthy development. The latest II data suggests last week’s sentiment shift was the former rather than the later. We will look to the AAII & NAAIM (released later this week) for confirmation that investors were just catching their breath.  

In this week’s Sentiment Report we look at how investors are responding to the recent price volatility and how that volatility may work...

From the Desk of Willie Delwiche

When the Fed raised rates to 4.50% in early February, the market was expecting that any additional tightening this Spring would be taken back (and then some) and that by the end of the year the Fed Funds Rate would be at 4.25%. Now, the market is pricing in a year-end Fed Funds Rate of at least 5.25%. Over the course of a month, market expectations for rates have shifted higher by a full percentage point.     

Why It Matters: Stocks stumbled in February as the markets digested the shift in expectations from “rate cuts by the end of the year” to a “higher for longer” reality. This led to investors who had been slow to embrace stock market strength to reconsider recently discovered optimism. We have documented that stocks tend to do well in the wake of persistent pessimism. Under-pinning this analysis is the assumption that pessimism is indeed fading. If expectations for higher rates lead to renewed pessimism, it will be difficult for sustainable strength to emerge. You need to have bulls to have a...

From the Desk of Willie Delwiche

The NAAIM exposure index surpassed its August high last month and has been on either side of its April high over the past two weeks. With price action cooling, active investment managers may regret their eagerness to increase equity exposure.    

Why It Matters: Active managers led the recent shift from pessimism to optimism. While sentiment overall doesn’t look ready to boil over at this point, there are some hot spots that could benefit from cooling. The NAAIM data, which has outpaced the recovery in price, is in that category. The broader sentiment risk is that a period of sideways price action leads reluctant optimists to turn bearish again. At this stage in the cycle we need bulls to have a bull market and a return to pessimism would likely add to downward pressure on price. This is all the more likely if volatility remains undiminished (only 4 years in the past quarter century began with more 1% swings in the S&P 500 than we have experienced so far this year) and breadth meaningfully...

From the Desk of Willie Delwiche

Last week was the first time in 45 weeks that the weekly AAII survey showed more bulls than bears. The most recent stretch of pessimism did not eclipse the Financial Crisis in terms of intensity (the bull-bear spread bottomed last year at -43%, versus -51% in March 2009).  But it did set the record for persistence.

Why It Matters: This newfound optimism is leading to some concern that the rally off of last year’s lows has run its course. This is based on the idea sentiment is always best used as a contrarian indicator. Leaning against sentiment tends to be most successful after it has reversed at extremes. The path higher for stocks becomes more clear as bulls replace bears. Rallies that are accompanied by rising optimism tend to be more sustainable. Optimism becomes a headwind after it becomes excessive and begins to fade. While on the watch for excesses, mostly we are seeing investors finally beginning to embrace stock market strength. At this point in the cycle, strength fuels optimism and optimism fuels strength. Increasing optimism after persistent pessimism is a welcome sight.

In...

From the desk of Willie Delwiche.

Bulls on the Investors Intelligence survey continued to climb while bears fell for the fifth week in a row. The bull-bear spread has now decisively cleared its August high as investors move to embrace the stock market rally.    

Why It Matters: One of the missing ingredients for sustained stock market strength last year was the embrace of investors. To be fair, investors did not abandon equities from a positioning perspective and, in fact, during the record stretch of more bears than bulls on the AAII survey, equity ETFs have still seen nearly a quarter-trillion dollars of inflows. Nonetheless, rally attempts last year brought neither broad market strength (in the form of new highs > new lows) nor a meaningful expansion in optimism. In 2023, investors are seeing strength and believing that it can persist. That can become a self-fulfilling prophecy (at least for a while). Almost all of the net gains in the S&P 500 since 2015 have come with the bull-bear spread above 18.

In this...

From the desk of Willie Delwiche.

The January AAII asset allocation survey shows household equity exposure rising for the third month in a row and climbing to its highest level since May.    

Why It Matters: Despite last year’s stock market turmoil and claims of pessimism, investors did not abandon equities. After approaching a 20-year high in November 2021, stock exposure waned over the course of 2022 but never did drop below its long-term average. Historically, the best gains in the market come after investors become bearishly positioned (stock exposure down and cash exposure elevated). That is a pivot that has not taken place this cycle (not yet, at least). The under-owned and unloved asset classes remain bonds and cash (and commodities, which don’t even make it as a category in the AAII survey).

In this week’s Sentiment Report we take a closer look at the implications of this positioning data, how investors are responding to stock market strength this year and what valuations tell us about risk and...

From the desk of Willie Delwiche.

The Investors Intelligence Bull-Bear Spread was unchanged last week, remaining just beneath the level that in the past has signaled  full embrace of equities and the opportunity for sustained stock market strength.    

Why It Matters: Excessive optimism can signal elevated risks for equities, but since 2015, virtually all of the net gains for the S&P 500 have come when II bulls have exceeded bears by 18% or more. For the past two weeks the spread has been stuck at 16.9%. The absence of bulls and a sustained re-building in optimism over the past year have been a headwind for stocks. The shift from excessive pessimism to elevated optimism is typically when stocks do their best, but this cycle investors have been slow to embrace rally attempts. With stocks strong out of the gate to start 2023, the lack of optimism is notable. If 2023 is not going to follow the path of 2022, investor attitudes about stocks will need to change. 

In this week’s Sentiment Report we take a closer look at...

From the desk of Willie Delwiche.

The Investors Intelligence measure of advisory services sentiment shows Bulls rising to their highest level in over a year. Bears have not (yet) undercut their summer lows and the Bull-Bear spread is still just below its August peak.    

Why It Matters: We need bulls to have a bull market. This flies in the face of a desire to only see sentiment from a contrarian perspective. The way I learned it, it pays to go with the crowd until it  reverses at an extreme. After the persistent and excessive pessimism of 2022 (which was certainly present in word if not deed), the best prospects for a sustained rally at this juncture is for investors to shift their attitudes and embrace stocks. A failure for investors to turn more optimistic at this juncture could hasten a longer-term positioning re-balance. We have gotten hints of that in recent weeks as ETF flows show investors eschewing US equities in favor of international equities and fixed income ETFs.  

In this week’s Sentiment Report we...

From the desk of Willie Delwiche.

Over the course of 2022, the two-year (8-quarter) return for the aggregate household portfolio dropped from one of the highest levels in over 40 years to underwater for the first time in over a decade.     

Why It Matters: Sentiment soured in 2022 but investors largely stuck with their equity exposure. They choose not to meaningfully increase their exposure to bonds or cash (and commodity funds actually experienced outflows last year). Now investors are reviewing portfolios that didn’t just experience a bad year, but are actually down over the past two years. This is unfamiliar territory for a generation of investors who are not used to sustained weakness and who see US large-cap equities as the only game in town. 

2022 was a bruising experience for many and 2023 is an opportunity to put aside broken paradigms and embrace forgotten realities. My expectation is that this leads to overdue discussions about proper diversification and adaptive positioning, across and within asset classes....

From the desk of Willie Delwiche.

Seems like almost everyone has a 2023 earnings estimate for the S&P 500. The thinking seems to be that if you are going to make up a year-end guess at price you should come up with one for earnings as well. That’s not a game I want to play.     

Why It Matters: It’s not the overall levels that matter, but whether those levels are being revised higher or revised lower. Earnings estimates for more and more companies were being revised lower over the second half of 2021 and the first half of 2022. That trend has stabilized  since mid-year. If the worst case for 2023 is priced in, there is room for both price and earnings revisions to move higher. If it is not, then the lows established over the second half of 2022 are not likely to hold. Remember, when it comes to adapting to incoming information, it’s not a question of whether it is good or bad, but whether it is better or worse than expected.

In this week’s Sentiment Report we take a closer look at how investors are feeling...

From the desk of Willie Delwiche.

Household equity exposure (as a percentage of total liquid assets) fell again in the third quarter dropping from 56% to 54%. It was at its highest level ever (62%) coming into this year and remains high by historical standards (90th percentile).    

Why It Matters: When equity exposure made a new high and then reversed in 2000, it ushered in a lost decade for stocks. The S&P 500 was no higher in late 2012 than it was in early 2000. The same was true in 1968. The S&P 500 was no higher in mid 1979 than it was in late 1968. While stocks were going sideways, household equity exposure was in secular decline. Equity exposure fell from 55% in Q4 1968 to 27% in Q4 1974 (when the S&P 500 bottomed). It dropped from 61% in Q1 2000 to 32% at the stock market low in Q1 2009. From this perspective, 2022 looks less like a one-off decline and more like year 1 of a secular bear market for equities. Opportunities will emerge and fade, but expecting a quick return to the market environment of the...

From the desk of Willie Delwiche.

The S&P 500 continues to make lower highs as new lows have approached, but not broken below, new highs. This breadth signal occurred as the S&P 500 was peaking in January. It re-emerged near the March and August highs and appears to be doing so again.   

Why It Matters: New high versus new low crossovers are usually fueled more by changes in the new low list than the new high list. New highs edge up slowly in the early stages of a bull market and can peak well before the indexes. The post-COVID bull market was a great example of that. But regardless of the driver, history shows it is important that they take place. As the longest bear market since the Financial Crisis has moved along, investors have been itching to turn more optimistic. But so far the price action (on the surface and below) isn’t doing much to change anyone’s mind or give rise to the increase in bulls needed to have a bull market.

In this week’s Sentiment Report we take a closer look at persistent...