Sentiment Getting Frothy, but Long-Term Bullish
With investors taking note of improving COVID-19 trends, an expanding US economy, and additional fiscal stimulus expected in the coming weeks, many are wondering if market sentiment is getting ahead of itself, and the stock market has certainly been on a tear recently. Since the presidential election on November 3, 2020, the S&P 500 Index is up over 15% on a total return basis as of February 23, and has climbed back over 76% since the market bottom on March 23, 2020.
As shown in the chart below, despite some inklings of volatility this week, the American Association of Individual Investors survey of bulls versus bears has been climbing (indicating bulls are outnumbering bears). However, the ratio still stands well short of the historical extremes, a point where there are roughly 40% more bulls in the survey than bears.
“We continue to be positive on stocks over bonds, but sentiment may be getting a little hot right now so we wouldn’t be surprised to see volatility pick-up,” noted LPL Chief Market Strategist Ryan Detrick. “Bond yields are also a bit stretched, so we may see them retrace a bit if stocks pull back.”
Often times when the market is suggesting a more substantial correction is on the horizon, credit markets will reflect the anxiety. Corporate spreads remain incredibly tight, and high yield spreads recently hit their lowest level since 2014. While the S&P 500 has suffered some weakness recently, we believe this is more due to the outsized weighting of mega-cap growth names. Since February 16, the technology and consumer discretionary sectors are both down at least 2%, however, sectors tied to the reopening trade have rallied significantly. Energy has gained 9.8% and financials more than 4%.
So where do we go from here? Near-term, we remain in the camp that equities have earned a well-deserved breather, and increasingly bullish sentiment may be raising the prospects of a correction. However, markets don’t always purely go up or down—a sideways consolidation to digest the gains of the past year is certainly a possible outcome.
Regardless of the prospects for stocks in the near-term, we continue to believe that an expanding economy, supportive fiscal and monetary policy, along with rising bond yields suggest an allocation to stocks over bonds. As we’ve noted in the past, volatility is the cost of admission for stock investors, and getting caught up in the short-term headlines can cause investors to lose sight of their time horizon.
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All index and market data from FactSet and MarketWatch.
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