Sunday, February 26, 2017

Sentiment In An Elevated Market

With the weekend nearly over and any research or reading completed, most investors now know the Dow Jones Industrial Average has been on a rare eleven day winning streak. What makes this more amazing is this is occurring as the market hits new highs with each close. One conclusion drawn from this seems to be the market is nearing a correction or consolidation point and I will be the first to admit, a pullback in the market would certainly be healthy. Since the U.S. election on November 8, the S&P 500 Index is up 10.6%, a return investors would find acceptable for an entire year. The strong and sustained market advance has led to a number of technical and sentiment readings approaching what seems to be elevated levels.

First, below is a chart of the S&P 500 Index along with its 200-day moving average. The chart shows the S&P 500 Index is trading above its 200-day moving average be an amount reflective of an overbought market.

Another sentiment measure I have written about in the past is the National Association of Active Investment Managers Exposure Index. The EI has been at a very high level since shortly after the election. if one believes in the contrarian nature of these sentiment measures, this high level of bullishness can actually be viewed as a bearish market signal.

Carl Swenlin, a contributing author at, featured the above chart in a recent article, Sentiment: Investment Managers Very Bullish. He notes in the article that high EI readings are not necessarily an immediate omen for the market.
"One of the things I wanted to point out is the fact that very high EI readings (blue up arrows) do not always signify a point of buying exhaustion that results in price correction. For example, the EI spike in early-2013 signaled a price advance that lasted almost two years. Also, in 2014 and 2015 the dotted lines show how, after initially high EI readings, exposure declined over several months before the price advances finally broke."
To further illustrate the point Mr. Swenlin makes, below is a chart showing the percentage of S&P 500 stocks trading above their 200 day moving average, The current 82% reading is near highs reached for this measure. And reiterating Carl Swenlin's point, these elevated levels can be sustained for an extended period of time. The S&P 500 Index continued to move higher for nearly two years after the percentage of stocks above their 200 day m.a. reached over 80%. Further, this percentage remained high as well during this time period.

And lastly, and maybe more importantly, individual investors are not indicating a high level of bullishness as reported by the American Association of Individual Investors. The latest bullishness level is 38.5% and extreme levels occur when this reading is near 50%. At least from a survey perspective, the individual investor is not expressing a high level of bullishness and the AAII bullishness reading is another contrarian measure.

Strictly from a sentiment perspective, these measures are providing mixed signals, not unlike some of the economic data. Importantly, stock prices often do not correct simply because prices may be elevated. Generally some sort of triggering event needs to occur. As important though is the fact steeper contractions or faster pullbacks can occur in this type of environment.

One added tailwind for the market, and an important one, that I have written about recently is the improvement in corporate earnings growth. A good summary of this earnings tailwind can be found in the LPL report, Earnings Update: Five Observations. In short, earnings growth has improved in each of the last two quarters. For all of 2017, S&P 500 earnings are expected to increase at a double digit rate versus 2016. And there is more truth than not to the fact stock prices tend to follow earnings, so the odds are in favor of 2017 still being a decent year for stocks. If we do get a positive year for U.S. stocks, one thing is nearly certain and that is the market will not move higher in a straight line.

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