The US stock market rally has been nothing short of astounding since the low on 23rd March. As it rallied, it pushed the Nasdaq Index COMP +0.90% into positive figures for the year to date. Though the broad market was not quite as robust as the Nasdaw, the S&P 500 SPX +1.15% is only 9.3% down from the end of 2019, not far from a correction.
Though most sentiment gauges have suggested that despite this rally most investors are closer to despair, a contrarian view point suggests that there is still more room to run in this rally.
Sentiment
According to short-term market timers, the sentiment index averages 31.2%, somewhat lower than the 60% it has enjoyed on almost every day of the last two decades. Something that doesn’t really scream of investor exhilaration.
Though this may seem to be fairly despairing, there are even more dismal outlooks that you can consider, especially if you have looked at the American Association of Individual Investors’ investor sentiment survey. 23.3% of those surveyed considered the market to be bullish whereas 50.6% considered the market to be bearish. A most pessimistic outlook, and it is the sixth pessimistic outcome of this survey in the last ten weeks.
The Economic Policy Uncertainty Index is an objective and comprehensive measure of, you’ve guessed it, economic uncertainty based on “the frequency of news media references to economic policy uncertainty, the number of federal tax code provisions set to expire in future years, and the extent of forecaster disagreement of future inflation and federal government purchases”. It was created by Scott Baker of Northwestern, Steven Davis of the University of Chicago and Nick Bloom of Stanford. Currently the EPU is higher that at any other time since the three professors began collecting their data back in 1985; showing that economic policy uncertainty has never been worse.
Contrarian
To contrarians, these sentiment measures, and many others, show that the mood of investors is at the very least sombre. Not only do they see this as relevant, but also that investors remained demoralized for as long as they did.
According to the NDR Daily Trading Sentiment Composite, the mood of investors was firmly in the “extreme pessimism” zone from 25th February to 28th April, 45 consecutive days, something that has only happened eight times since 1980. Ned Davies Research’s (NDR) Chief US Strategist, Ed Clissold has reported that following these other seven occasions, the market subsequently produced above-average gains.
Though not every sentiment indicator has a gloomy outcome on the market, the mood that is prevailing could easily be called despondent.
Where does this lead?
When you consider the current market rally, the sentiment indicators and the data from the Citi Panic/Euphoria Model, there is a suggestion that prices in a years time will be lower than they are today.
The current Citi Panic/Euphoria Model is currently showing the mood as bordering on euphoria at the upper edge of its neutral zone. Any reading that falls in the euphoric zone on this model has an 80% or better probability that prices will be lower one year later.
Though the current market mood is not euphoric on their scale, it is expected that the market rally will continue for a few more weeks, but ultimately prices will be lower in a year. However, this is not the only possible scenario and as long-term investors and bargain hunters continue to invest, this rally could herald a much more optimistic market recovery.
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