Can Extreme Optimism Trip the Bull

As of April 30, 2019, the S&P500 is up roughly 17% on the year.  That’s fun to say. But in reality, the recent performance is less impressive when viewed with a longer time frame.  The last 15 months have been a frustrating series of falls and rises for equity investors. From January 22, 2018 until today the S&P500 has posted a price return of only 1.77%, not great over a 15-month time span. 

2018 was a strange, wild ride.  A strong January was followed by a sharp selloff in the spring as fear arose of a global slowdown in growth.  The US stock market stabilized and rallied again into September making a brief all-time high only to fall again in the fourth quarter. From peak to trough, stocks fell nearly 20% from the September high to the December 24th low. Meanwhile, foreign stocks have been even worse than their US counterparts over the last 15 months, posting a return of -12%. Despite the strong start to the year, a well-diversified mix of US and foreign stocks has delivered some subpar results over the last 15+ months.

The recent market swings raise some interesting questions: which occurrence was the anomaly, the last 3 months of 2018 or the first 4 months of 2019?   Was the fear of a global slowdown in December just a blip on the radar? Or… Should investors use this market rally as an opportunity to take chips off the table? Four months ago, investors were convinced that the economy was sliding into a recession.  Today, investor optimism is hitting extreme levels (as measured by Ned Davis Research – discussed below). Which stance is correct? 

I maintain that the most likely scenario is that the stock market is in a long-term “topping” process.  We are currently making our third peak on the mountain range (January 2018, September 2018 and April 2019).  It’s easy to get caught up in the emotion of a market rally and want to chase returns… but doing so can be a dangerous game. 

At Raanes Capital Advisors, we make investment decisions based on indicators and rules.  Unfortunately, the indicators don’t point to very attractive future returns. Investors are simply too optimistic at the moment.  Ned Davis Research takes a weekly poll to determine “crowd sentiment” that gauges optimism and pessimism about the stock market.  Any reading over 66 is classified as “extreme optimism.” Last week’s gauge was 70.33.

Interestingly, these instances of “extreme optimism” have historically been a precursor to declining returns.  According to Ned Davis Research, from 12/1995 – 4/2018 the annualized returns for the S&P 500 has been -3.71% when the reading has been above 66.

While it’s tempting to try and chase the recent rally, investors may be wise to take a broader view and use market rallies as opportunities to reduce risk as needed.

Any opinions are those of Brady Raanes and not necessarily those of RJFS or Raymond James. The information contained in this report does not purport to be a complete description of the securities, markets, or developments referred to in this material. There is no assurance any of the trends mentioned will continue or forecasts will occur. The information has been obtained from sources considered to be reliable, but Raymond James does not guarantee that the foregoing material is accurate or complete. Any information is not a complete summary or statement of all available data necessary for making an investment decision and does not constitute a recommendation. Investing involves risk and you may incur a profit or loss regardless of strategy selected. The S&P 500 is an unmanaged index of 500 widely held stocks that is generally considered representative of the U.S. stock market. Inclusion of the index is for illustrative purposes only. Keep in mind that individuals cannot invest directly in any index, and index performance does not include transaction costs or other fees, which will affect actual investment performance. Individual investor's results will vary. Past performance does not guarantee future results. International investing involves special risks, including currency fluctuations, different financial accounting standards, and possible political and economic volatility. Commodities trading is generally considered speculative because of the significant potential for investment loss. The price of gold has been subject to dramatic price movements over short periods of time and may be affected by elements such as currency devaluations or revaluations, economic conditions within an individual country, trade imbalances, or trade or currency restrictions between countries.