Trending
The old saying that the bark is worse than the bite is a good description of the current state of the stock market and investors’ sentiment. The following quote from a recent Commentary and our most recent article (summarized and linked below) point to the unusually poor sentiment.
The AAII retail investor survey is now the most bearish it has been since September 2022. More stunning, this is only the sixth time since 1987 that bearish sentiment has been above 60%. Furthermore, the five-week change in the index is the third largest in history.
However, what stands out to us is that horrendous investor sentiment is at levels associated with market bottoms occurring after much deeper sell-offs. Thus, seeing such sentiment after a relatively small 8% decline is highly unusual. The Sentimentrader graph and the tables below show that forward market returns tend to be good when bearish sentiment is as high as it is.
There is another saying: When everyone is on one side of the boat, go to the other side. Everyone is on the bearish side of the boat. With sentiment this poor, a rally, even if brief, is likely.
What To Watch
Earnings
Economy
Market Trading Update
Yesterday, we discussed the more extreme oversold level of the U.S. dollar and the potential for a reversal. Today, we will return our focus to the US market, which remains oversold but is still struggling with the recent repricing due to tariffs, recession concerns, or other reasons. For example, there is currently minimal risk of a recession, a topic we will explore in Friday’s #Macroview blog. For example, yesterday, industrial production hit a new all-time high which is not something you would see if the economy was flirting with a recession.
Also, while weaker, retail sales were not recessionary. Retail sales remain at levels more consistent with slower economic growth but a contractionary environment.
While the economic data does not suggest recession risks currently, it DOES suggest solwer economic growth which will impact forward earnings expectations. The question is whether the current decline has recalibrated evaluations enough as of yet. I suspect that the answer is “no” and will require a further consolidation/correction process. However, as shown, the market is trading at more deeply oversold levels, and money flows have reached levels that are more coincident with short-term bottoms rather than further corrections.
I suspect that “if” we form a short-term bottom, it will be messy. There are many investors who are “trapped” in the recent decline and will sell on any rallies. However, as long as the market can hold recent lows, and reduce selling pressure, the market should be able to form a rally that could last a few weeks. For now continue to manage risk as needed.
Political Sentiment
The graph below, courtesy of Macrobond, is very telling. It charts the University of Michigan Consumer Expectations Index. Before focusing on the current data, it’s fascinating to see how sentiment changes based on whether those surveyed are Democrats or Republicans. The dark blue (Republicans) and light blue (Democrats) lines flip-flop with each change as the party of the President changes. Furthermore, those changes in sentiment are nearly instantaneous with the elections.
Most recently, with Donald Trump becoming president, Republican voter sentiment soared while those of Democrats plummeted. It’s easy to claim polls such as these are irrelevant as they are so swayed by political affiliation. However, there are some critical takeaways. First, the expectations of Republicans and Democrats are below where they stood during Trump’s first term. Second, the expectations of Republicans are starting to decline. Thus far, it’s not abnormal, but it will be interesting to see if it continues downward, especially if the stock market continues its slide.
Also of note in the survey, unemployment expectations have surged to levels “never seen before” except in prior recessions. Inflation expectations also jumped. Tariff threats are likely responsible for both significant changes.
Retail Investors Buy The Dip Despite Bearish Sentiment
Not surprisingly, investors were terrified when the market entered correction territory last week (a decline of ~10%). Our composite index of retail and institutional investors showed that fear was rampant. As shown, the standard deviation of net bullish sentiment was at the lowest level since the depths of the 2022 market correction and the “financial crisis.”
The fact that retail investors were so bearish after a minor market correction is something rarely witnessed in the markets. Charles Rotblut of the American Association of Individual Investors made a similar point.
Tweet of the Day
“Want to achieve better long-term success in managing your portfolio? Here are our 15-trading rules for managing market risks.”
Related: Retail Investor Buys the Dip Despite Bearish Sentiment