As I write this, the S&P 500 is now at levels where it was in October of 2019, a little less than seven months ago. What were you doing last October? I’m guessing you were not searching store shelves for toilet paper and wondering where you could buy a gallon of hand sanitizer to refill the bottles scattered in various places around your house. I first heard about “the coronavirus,” which we now know is a broad term for a whole category of viruses, in mid January. We know just how destructive this pandemic has been to wide areas of our economy, let alone the death toll it is leaving behind. However, we still have no idea what the short and medium term will look like for any of us, or for the economy—even the “experts” are just guessing. I’m optimistic that the long term will work out just fine, but as Keynes famously said, “in the long run we are all dead.”
No policy maker, government official, economist, or strategist knows for certain:
- How long the virus will be with us,
- How it will affect the economy,
- How corporate earnings will play out, or
- When there will be a vaccine.
We have all been taught that “markets hate uncertainty,” so how is it that the levels of the market are the same as seven months ago, when:
- There was no known virus that was about to shut our economy,
- Economic growth was pretty solid,
- The S&P 500 was expected to earn roughly $170/share (give or take), and
- “Vaccine” was probably a lot lower on the Google search list than it is now.
With so much uncertainty I think many investors are perplexed by the rapid snap back above 2,900, particularly with very little visibility as to what 2020 earnings will be, and for that matter even 2021 earnings. Two weeks ago I wrote a blog piece titled “Don’t Fight the Fed,” where I relayed my work with Marty Zweig who built a model to determine investment exposure to stocks (versus cash or bonds). The three basic components were Monetary, Sentiment and Momentum. The Fed part was monetary and about 60% of the model, but 30% of the model was sentiment, or as Marty liked to say “beware the crowds at the extreme.” Another axiom we learned over the years is that bull markets “climb a wall of worry.” The manner in which we ascertained where market sentiment was through internal polls of investors, indicators like the put/call ratio, and outside surveys such as the American Association of Individual Investors, which is shown right here:
We typically just looked at the Bulls versus the Bears in determining the level of optimism or pessimism, but again the axiom “beware the crowds at the extreme” is the overarching point. Despite the sharp move higher, sentiment in this market remains overwhelmingly negative. It will be interesting to see where this week’s AAII survey comes in, but a level of 50% bearish (and only a quarter of the participants bullish), is near an extreme. Here is the last six months of data:
It is not surprising that in the throes of the early stages of Covid-19, where New York was seeing hospitalization rates skyrocket, businesses were forced to shut down, people were required to “stay at home,” schools were closed, and the market went into a free fall, of course bearish sentiment hit 51%. Once the market started to rally off the bottom, you can see from the above chart that in early and mid April (9th and 16th) that bearishness abated somewhat and bulls versus bears was down to around 8% to the pessimistic side, but not extreme. However, whether it was the wild ride in oil last week, or just the levels of the market, a relatively sophisticated group of market participants (the AAII survey group) are back to more than 25% bears to bulls, with 50% of surveyors outright bearish- which is more pessimistic than at the bottom of the Covid-crash. The market is now “climbing a wall of worry.”
I find the economic uncertainty alarming, and we don’t know if there will be a “second wave” of the virus, or what happens to all the jobs lost in this forced business closure? However, in the absence of some new exogenous shock, the market will be hard pressed to “trade heavy” with so much latent pessimism. The market tends to inflict the most pain on the most people—“beware the crowds at the extreme”—and the pain trade feels higher as long as the market remains “short” on optimism and “long” on pessimism.