It seems almost nobody in the stock market is feeling good right now. That’s usually sign that things could turn around soon.
For starters, the
has fallen 14% from its mid-August peak of a summer rally. It’s now down more than 20% from its all-time high in early January, putting the index into bear-market territory. The core driver has been stubbornly high inflation, which is pushing the Federal Reserve to rapidly lift interest rates. That threatens to reduce economic demand, and many are now worried about a recession.
Now, market sentiment is at historically low levels. The American Association for Individual Investors’ survey recently showed a reading of lower than negative 30%. That’s the percentage of bullish respondents minus that of bearish respondents and it means that there are more bears than bulls. It’s the lowest result since 2008, according to RBC, in the aftermath of financial crisis when all forecasts were for a horrid recession. Sentiment doesn’t usually go lower than that level. In fact, one has to look back to 1990 to find a time when it did.
Consistent with that, the last time sentiment was at this level, forward stock market returns were stellar. The S&P 500 posted a gain of more than 30% a year after sentiment was this low in 2008, RBC data show. This shows that when the market is already deeply in the red—with a lousy outlook for corporate earnings and economy to boot—signs of improvement can lift sentiment, and send stocks surging.
Indeed, it seems a lot of capital is looking for an opportunity to plow into the stock market. Bank of America’s survey of trillions of dollars worth of portfolio managers reveal an average portfolio cash holding of 6.1%. That’s the about highest level since late 2001. It means portfolio managers have already done a lot of selling. Now they’re holding a lot of cash that isn’t earning nearly as much as the stock market could potentially yield. When cash holdings are this high, it’s historically a buy signal, according to Bank of America.
That may sound overly optimistic, and there’s certainly a caveat. The fear is that earnings expectations have to decline from here, a process that has already begun. Higher rates tend to affect the economy on a slight delay, and with third-quarter-earnings reports on the way, the market is braced for poor results. Maybe the S&P 500 could fall to its 2022 intraday low of 3,636.87, which it is currently hovering above.
But maybe the economy—and earnings—aren’t going to decline as much as feared. A few developments could drive improved expectations, such as better-than-feared third-quarter results. Another would be a continued decline in the rate of inflation, which would go hand-in-hand with the Fed slowing down the pace of rate hikes, relieving pressure on the economy
As Sevens Report’s Tom Essaye puts it, “Sentiment, meanwhile, has become extremely negative. While we can’t say the bottom is in, we do feel that we are closer to the end of this than the beginning, and all the market needs to stabilize is the hope that: 1) Inflation is receding, and 2) The Fed is close to the end of its hiking cycle.”
Once the market has confidence that those things are happening, investors will start putting all that cash to work—and sending stocks higher.
Write to Jacob Sonenshine at email@example.com