Market Climbing A Wall Of Worry: Weakening Bullish Investor Sentiment

AAII reported bullish investor sentiment fell 5.83 percentage points to 20.23% in the Sentiment Survey release today (7/30/2020.) This is the lowest bullishness reading since bullish sentiment was reported at 17.75% on May 26, 2016. The Sentiment Survey is derived from AAII's requests of its members to report their expectation about the stock market's direction in the upcoming six months.

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An Economic Tailwind Would Be Favorable For Stocks

With the consumer accounting for nearly 70% of economic activity, this past week's jobs report came in on the disappointing side of the ledger. With state governors continuing to pause some reopening of their respective states, it is not a surprise that the jobs report disappointed. Claims on a non-seasonally adjusted basis fell, but declined less than consensus expectations. The bigger issue in my view is the number of continuing claims of all individuals for all the unemployment programs. The total number of individuals receiving benefits equals nearly 32 million. That is an unemployment rate over 21%. The headline continuing claims number is reported at 16.4 million, but does not include the recently established large Pandemic Unemployment Assistance category which totals 13.2 million individuals. These are persons who do not qualify for typical unemployment benefits.

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Strong Rebound In The June NFIB Small Business Optimism Index

I still believe the recent economic data is experiencing a "V-shaped" recovery and the equity market seems to concur. So many times though, we do note the market and the economy do not always react to the same information. With the S&P 500 Index's 1.34% gain today, it is now up .40% on the week. Over the last eight trading days the market is up 6.14% since June 29. If the market finishes positive this week, it will be the third consecutive week of positive gain for the S&P 500 Index.

Today the National Federation of Independent Business (NFIB) reported that the Small Business Optimism Index increased 6.2 points to 100.6. Also included on the below chart is the fact more firms are expecting an improved economy six months from now versus a worse one. 

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Mutual Fund And ETF Flows Don't Favor Stocks

As is said from time to time, a picture is worth a thousand words and one simply needs to look at mutual fund and ETF flows to see the truth behind the statement. Investors' actions indicate stocks have not been at the top of their buying list for a year and a half. As the top two panels in the below chart show, cumulative mutual fund and ETF flows for stocks have been decidedly negative for a year and a half.

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Summer 2020 Investor Letter: A "V-Shaped" Market Recovery

The speed of the market decline in the first quarter was unprecedented and the ensuing recovery in the second quarter was as impressive as the gut-wrenching decline in Q1 2020.

Our Summer 2020 Investor Letter contains commentary on the economic and market impact precipitated by the virus mandated shutdowns. With the third quarter underway it seems the worst of the economic damage caused by the virus-induced stay at home mandates just might be behind us. States are reopening their economies resulting in a significant pickup in economic activity, albeit from a low level. The fiscal and monetary response to the virus-led economic shutdown is substantial and provides interim support for businesses and consumers, allowing time for businesses to reopen and bring back furloughed employees.

Our Summer 2020 Investor Letter contains additional commentary on the current environment and our expectations for the balance of the year. More insight is accessible at the Investor Letter link below.

• Summer 2020 Investor Letter

The "V-shaped" Recovery Continues: Now It Is The ISM PMI and Non-Manufacturing Index

I have noted in a few recent posts that much of the economic data being reported is recovering in a "V-shaped" manner. In other words the economic rebound taking place as states are reopened and businesses get up to speed is occurring at a strong clip. Today's ISM Non-Manufacturing Index report came in at 57.1%, an increase of 11.7 percentage points over May's 45.4% reading. ISM noted this was the largest single month increase in the index's history going back to 1997. Last week's ISM report on the Purchasing Manager's Index (PMI) jumped into expansion territory with the PMI coming in at 52.6%, up 9.5 percentage points from May's reading.

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A Healing Job Market And Economy But Poor Investor Sentiment

It is hard not to look at much of the recent economic data and not come to the conclusion a V-shaped recovery seems to be unfolding. Certainly many of the reports are coming off depressed levels; however, a sharp recovery is occurring nonetheless. Today's nonfarm payroll number is another example with a month over month increase of 4.8 million versus a consensus expectation of 3.0 million increase.The labor market still needs healing, but payrolls are up 8 million in two months.

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Leading Economic Index Joins The "V-Shaped" Data Recovery

Last week the Conference Board released their report on the Leading Economic Index (LEI) along with data on the Coincident Economic Index (COI). The LEI rose 2.8% in May after falling 7.5% in March and down 6.1% in April. The report notes the improvement in unemployment insurance claims accounts for about two-thirds of the LEI improvement. With consumers representing a large part of the economy, an improvement in the job market is important. Three of the ten components that go into the LEI calculation are suggesting weaker economic conditions, one being the new orders component. The Coincident Indicator rose 1.1% after falling 2.2% in March and down 10.4% in April. In evaluating the ratio of the LEI to the COI, one can clearly see the "V-shaped" rebound occurring with this data metric. A trend reversal with this ratio tends to occur as the economy looks to be recovering.

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Individual Investors Expressing Equity Market Skepticism

Individual investors continue to express a low level of enthusiasm for stocks if the AAII sentiment survey is any indication. Today's AAII Sentiment Survey report noted individual investor bullish sentiment declined 9.9 percentage points to 24.4% with most of the decline showing up in the bearishness reading which increased 9.7 points to 47.8%. The bull/bear spread now stands at a wide -23.4 percentage points.

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Market Telegraphing A 'V-Shaped' Economic Recovery?

If one is only looking at the stock market, that is the S&P 500 Index, a 'V-shaped' recovery has unfolded off the March 23 low. Not too many expected this type of recovery as the virus/lockdown induced contraction was underway. However, on a price only basis, the S&P 500 Index is up 43.34% since the low on March 23.

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Individuals Save In April With Many Businesses Shutdown

Last Friday's April Personal Income and Outlays report from U.S. Bureau of Economic Analysis reported a significant month over month increase in personal income, up 12.9% and a dramatic increase in savings as a percentage of disposable income, up 33.0%. At the same time the income and outlays report showed a significant decline in personal consumption expenditures (PCE), down 13.2%.

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Negative Interest Rates And The Impact On Investor Investment Choices

One phenomenon investors face today is the fact central banks around the world have moved to a negative interest rate posture. Earlier this month Federal Reserve Chairman, Jerome Powell, stated the U.S. Federal Reserve is not considering moving the Fed Funds Rate to a negative level though. Yet, rates in the U.S. are near zero with the Fed Funds target rate at .25% or 25 basis points. A one month U.S. Treasury Bill yields just under 13 basis points. In other words, rates are near zero and going to a negative level is not out of the realm of possibility. One recent article notes if the Fed does push rates to a negative level it will do so in a meaningful way, maybe as low as minus 100 basis points or minus one full percentage point. What are the implications of negative rates if this were to be realized?

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JOLTS: How Quickly Things Can Change

Just a few short months ago I was writing about the tight job market and the fact the number of job openings continued to exceed the number of those unemployed. This had been the case since February 2018 and was a sign of a strong economy. How quickly the tide can go out.

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Weak Small Business Optimism, But Expectations Of A Short-Lived Recession

Not surprisingly, small business owners are anything but optimistic about the current environment. The NFIB Small Business Optimism Index fell 5.5 points to 90.9 in April. The NFIB report notes the index has declined 13.6 points in two months. The index is now at a level below the recession in 2001 that occurred after the bursting of the technology bubble.

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A Dreadful Employment Report

Much was written about the employment report on Friday, yet the the S&P 500 Index rose 1.69% and the Dow Jones Industrial Average rose 1.91% on the day. As much of the commentary notes, me included, the equity markets are forward looking. Not enough can be written about how bad this report is though. The equity market will eventually not look past this data if a V-shaped improvement is not seen in the economy and employment. Total civilian employment from the household survey fell be over 22 million individuals--a staggering decline.

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Approaching Maximum Investor Bearish Sentiment Level

Not to surprising that the individual investor sentiment as reported by the American Association of Individual Investors (AAII) this week continues to deteriorate. As seen in the below chart, this week's bullish sentiment is reported at 23.7% down 6.9 percentage points from the prior week. The economic reports over the last few weeks have been absolutely terrible and it does not seem the reported economic data can get much worse. However, as states are now in the process of reopening their economies, better economic data may not be on the too distant horizon.

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S&P 500 Dividend Aristocrats Lag In This Down Market

A favorable characteristic of the S&P 500 Dividend Aristocrats is this basket of stocks generally holds up better in broader market pullbacks as seen in the below table. Where the entire row is highlighted, it represents a significant market pullback and the Aristocrats outperformed the S&P 500 Index by double digits. The S&P 500 Aristocrats are companies in the S&P 500 Index that have increased their dividend each year for at least 25 consecutive years. The companies are then equally weighted in the Dividend Aristocrats Index. I have written about the Aristocrats several times in the past with a more comprehensive article at this link.

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Investor Cash Continues To Build

This past Friday our webinar looking at contrarian indicators included commentary on the level of cash in money market mutual funds. The below money market chart is an update from the one in the webinar and the chart shows cash levels continue to rise, now equaling $4.73 trillion. Clearly the current cash level is higher than the level reached at the peak of the financial crisis in early 2009.

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Retest The March Low Or Not

The economic and equity market environment investors find themselves operating in today are different and more challenging than any environment they have likely faced in their lifetime. The steep market contraction from the February high was swift, i.e., declining 33.9% over a short 22 trading days, the fastest on record. With a nearly global economic shutdown due to mandatory stay at home orders, the economic growth rate, or should I write, contraction, is turning out to be severe. The CBO's estimate of U.S. second quarter GDP is for a contraction of nearly 40% at an annual rate. Over 26 million jobs have been lost in five short weeks, wiping out the job gains that were generated following the financial crisis of 2008/2009. So in the face of this poor economic data, will the equity market retest the March 23 low?

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Investor Bullish Sentiment Weakening

Until today I had been surprised individual investor sentiment was holding up at an elevated level. However, with the AAII Sentiment Survey release this morning, for the week ending 4/22/2020, bullish sentiment fell 10 percentage points to 24.9%. This is the lowest bullishness reading since October 10, 2020 when bullish sentiment was reported at 20.3%. A majority of the formally bullish respondents flipped to the bearish category this week, where it rose 7.3 percentage points to 50%.%.

The sentiment readings are contrarian ones and looking at them on their own, a further weakening would be one positive metric for higher equity prices.