Why are investors so glum?

The market is turning into somewhat of a hamster’s wheel: there’s a lot of spinning around but nothing’s really going anywhere. Markets have been volatile, and they are down between 5-15% year-to-date depending on what index you look at. Our preferred benchmark for stocks, Vanguard’s Total World Market index (VT) is down 8.25% year-to-date and 1.50% over the last one year. On the plus side, VT remains 5% above its year-to-date low, and is also above its January low.

Things seem pretty bad

The year started with a quick 7% pullback across the board, so that January low was somewhat significant. After all it was one of the worst first month pullbacks, ever. So being above that January low now is pretty interesting. Aren’t things much worse than they were in January? Consider the following:

Inflation, running hot to start the year, has gotten even worse
Mortgage rates have risen from under 3.50% in January to over 5%
A war broke out between two developed nations when Russia invaded Ukraine
The fed has gone from targeting a 1.50% fed funds rate to now targeting 2.50%
Covid outbreaks in Asia have reinstated lockdowns in China, disrupting supply chains once more

These are all tangible negative catalysts for stocks. Why aren’t stocks lower now, with this new information, than they were in January? I can’t say I know the answer, but I can say I am encouraged by the market’s resilience. In my experience, when markets absorb negative information without declining significantly in price, it’s a reason for optimism.

Everyone has given up on stocks

I’m not here to pretend that the market is in great shape. As alluded to earlier, a broad market benchmark like VT is now negative over the last year. To own stocks for a year and have zero gains to show for it is no fun, especially when considering inflation; there’s no denying that. Current investor sentiment reflects this lack of joy.

The American Association of Individual Investors (AAII) surveys investors on if they are bullish, bearish, or neutral on the stock market over the next 6 months. This last week’s survey generated the lowest percentage of bullish responses since 1992!

Investor sentiment is highly correlated with market performance: investors get bullish when stocks are rising and bearish when stocks are falling. So it’s not a surprise that investors are not bullish right now since stocks have not been rising. What’s remarkable though is just how pessimistic they’ve become. Investors are less bullish now than they were during…

The Covid bottom (March 2020)
US credit downgrade (August 2011)
The Great Financial Crisis (2008/2009)
9/11 (September 2001)
Dot come bubble burst (2000-2002)

Sure, things are not great right now, but are they objectively worse than any of the above events? The unemployment rate during each of those events was as follows:

14%
9%
rose from 7% to 10%
5%
rose from 4% to 6%

Today’s unemployment rate sits at 3.6%, which is near the lowest in 50 years.

So what should we expect?

In putting together an outlook for the rest of the year, there are competing forces in the economy. On the negative side, historically high and persistent inflation is a very legitimate worry. On the positive side, jobs data and consumer spending continues to paint a steady picture.

The basic bullish argument goes like this: inflation is peaking and as it does, the strong consumer will naturally be even stronger. The basic bearish argument goes like this: inflation will remain stubbornly high and eventually erode consumer confidence to the point where it crimps spending and slows down the economy. This will have negative consequences for just about everyone.

Who scores these debates? We’re not quite sure, but we prefer the scoreboard of the stock market. In that case we would say that the market is currently showing enough resilience to believe that it expects the bullish argument to win out. If the market was as bearish as investors in the AAII survey were, it would be down more than 8% on the year. To us, the market is expressing a belief that things will get better, not worse.

We expect the market to remain in a trading range for a while longer but believe the odds are increasing for a 5-10% rally in the second half of the year.