Thursday, May 18, 2023
The latest weekly data from the American Association of Individual Investors (AAII) showed individual investor sentiment is still at depressed levels. This is perhaps not surprising as investors have built up a “wall of worry” from concerns about lingering inflation, uncertainty over the path of interest rates, recent bank failures, recession fears, and depressed consumer sentiment, not to mention concerns over the debt ceiling and the potential for a U.S. debt default and/or credit downgrade.
The percentage of individual investors who are bullish about short-term market expectations is 23%, down from 29% last week. This marks the lowest level since the end of March and is well below the long-term average of 34%. The percentage of investors who are bearish slightly decreased week-on-week to 40% but was still well above the long-term average of 32%. This puts the spread between the bulls and the bears at -17%, versus a long-term average of +2%.
As shown in chart the below, investor sentiment, as measured by the spread between bulls and bears in the AAII data, is more than one standard deviation below its long-term average. The January rally in the S&P 500 brought some bulls back, with the bull-bear spread getting above zero for a single week, but since then investor sentiment has fallen despite stocks recovering in March and mostly trading sideways since then.
While the concerns that are feeding into the individual investors’ “wall of worry” are valid, the negative sentiment they have built up is, from a contrarian perspective, a potential catalyst for positive forward returns. Stock markets are forward looking and if concerns are well known and understood they are also probably largely priced in. Markets typically slump due to surprises and shocks, not known risks. As such, we view the negative sentiment in the AAII data as a contrarian indicator, suggesting support for stocks, as many potential buyers wait in the wings for current worries to subside. Extremes in pessimism in the AAII data are, on average, bullish for near-term stock market returns (and extreme investor optimism tends to be bearish for the near-term outlook). When the bull-bear spread is around where it is now (between 1 and 2 standard deviations below average), we have seen the strongest S&P 500 returns three months and 12 months out, and the second strongest returns six months out.
Some other data points are currently showing extreme levels that may also support a contrarian view that there may be additional buyers out there for stocks:
- The Commodity Futures Trading Commission’s (CFTC) weekly Commitments of Traders (COT) report shows that speculative traders in U.S. futures markets have the largest net short position in S&P 500 futures contracts since 2011. These short positions will have to be closed out at some point in the future, which could provide a tailwind for stocks.
- Money market mutual fund assets are at record highs—money often flows into these products as nervous investors pull assets from stocks—but we have seen extreme flows in the last year as short-term yields have also become very attractive. Part of this may also be accounted for by movement from bank deposits to money market accounts spurred by regional bank uncertainty and higher yields, as well as movement from traditional bonds into money market accounts given a historically rough year for bonds in 2022 and an inverted yield curve. The overall effect has bumped up total money market fund assets to over $5.3 trillion, $500 billion higher than the previous peak seen in May 2020 and $800 billion higher than a year ago. If short-term rates and market worries do ease, some of these assets are likely to be reinvested in equities, a potential boon for stock prices.
Summary
There are many risks out there for markets and the economy that have justifiably built up a significant “wall of worry,” but one remaining asset for stocks, from a contrarian perspective, is all this negative sentiment and positioning. We still maintain a modest overweight to equities funded from cash (where the return profiles of short-term products are very attractive, but reinvestment risk has also risen), as equities may still benefit from falling inflation and the potential end to Federal Reserve rate hikes. We recommend a neutral allocation to fixed income, as valuations have become more attractive relative to equities amid higher interest rates.
IMPORTANT DISCLOSURES
This material is for general information only and is not intended to provide specific advice or recommendations for any individual. There is no assurance that the views or strategies discussed are suitable for all investors or will yield positive outcomes. Investing involves risks including possible loss of principal. Any economic forecasts set forth may not develop as predicted and are subject to change.
References to markets, asset classes, and sectors are generally regarding the corresponding market index. Indexes are unmanaged statistical composites and cannot be invested into directly. Index performance is not indicative of the performance of any investment and do not reflect fees, expenses, or sales charges. All performance referenced is historical and is no guarantee of future results.
Any company names noted herein are for educational purposes only and not an indication of trading intent or a solicitation of their products or services. LPL Financial doesn’t provide research on individual equities. All information is believed to be from reliable sources; however, LPL Financial makes no representation as to its completeness or accuracy.
All index and market data from FactSet and MarketWatch.
This Research material was prepared by LPL Financial, LLC.
Securities and advisory services offered through LPL Financial (LPL), a registered investment advisor and broker-dealer (member FINRA/SIPC).
Insurance products are offered through LPL or its licensed affiliates. To the extent you are receiving investment advice from a separately registered independent investment advisor that is not an LPL affiliate, please note LPL makes no representation with respect to such entity.
- Not Insured by FDIC/NCUA or Any Other Government Agency
- Not Bank/Credit Union Guaranteed
- Not Bank/Credit Union Deposits or Obligations
- May Lose Value
For Public Use – Tracking # 1-05370961