From Extreme Pessimism to Growing Optimism

When investors reach an extreme consensus of optimism or pessimism, we can be assured that the opposite is about to occur. The trick is knowing when those ever-changing thresholds of sentiment have climaxed. The extremely negative investor in 2022 was understandable as the Federal Reserve was on a quest to choke off 40-year high inflation rates, which typically generates a Recession in the economy and corporate earnings. At the end of 2022, one year into the Bear market, there was still no sign of a recession. Sapient money managers assumed for the first time in decades that stock prices would fall in 2023 when the overdue recession would finally arrive. Contrary opinion appears to be working once again as equity prices are experiencing exceptional appreciation through the first half of 2023. While the gains would be quite modest if not for large-cap technology stocks, the market is not declining as most expected. 

It’s been 18 months since the 2022 Bear market in stocks began and there are still no signs that the US or Europe is on the cusp of an economic or earnings recession. After 18 months of turmoil back in 2007 – 2009 the massive equity Bear market was over, and the economy began to recover. Today we remain in full employment, with over 10 million job openings that have to partially disappear before the consumer begins to subsist on unemployment checks. The naysayers are always searching for tea leaves to foretell bad tidings ahead. The latest major indication that the Sky Was Falling triggered in March when several top 30 US Banks failed. Credit Default Swaps (CDS), as a proxy for a US default, soared to record heights, compounded by a political impasse over funding $32 trillion in US debt. Bears were certain the other shoe would drop soon, yet the Fed backstopped dead banks, facilitated the merger of others and Congress passed a new Debt Ceiling. CDS premiums have now capitulated back to normal levels and stock prices moved higher throughout the CDS rollercoaster. Was there ever any doubt? The prior CDS spikes in 2008 and 2011 coincided with stock market panics. This time stocks took a breath in March and then rallied 10% due to mega cap technology stocks roaring higher. Central Banks learned from the Great Financial Crisis of 2008 how to use their infinite check book to bail out financial panics faster than ever before.

Another measure of sentiment the Bears would use to conclude a moribund consumer was about to cut up their credit cards was the Michigan Consumer Sentiment survey. Initially the consumer was worried about how long Covid and the accompanying political restrictions would last in 2020 and 2021. Then sentiment fell to 60-year lows as everyone worried about high inflation, painful borrowing costs and an impending recession that experts assured them was ‘coming to a job near you’. While short term overbought levels in stocks are being reached this summer, it is worth noting that when the Michigan Consumer Sentiment survey falls below 70 and then rebounds, it has always been a sign that the economy and stock market are entering a more positive environment. 

Our proprietary indicators of sentiment and momentum are mostly in the overbought zone of optimism warning of short-term trouble brewing, even though the longer-term picture keeps improving. With positive seasonality and actual earnings beating consensus forecasts, we expect any corrections to be brief until later in the Summer.  So far, the minor pullback in the overall uptrend we expected by the 2nd half of June, has not materialized. This is not a time for draining money market cash positions yielding 5% in order to add to a stock portfolio now that the Price/Earnings multiple on the S&P 500 Index is pushing 20 and the Russell 2000 is at 30. Should Bond yields fall this summer, higher multiples will be justified as well as incentivizing sideline cash to move back to stocks. Our maximum summer upside we outlined a couple months ago in the 4600’s on the S&P remains (~4560 – 4670).

A closer look at the S&P with the Daily chart reveals that we just tested the next resistance zone at 4495 right on one of our inflection dates (June 16th). The Relative Strength (RSI) momentum metric signals some near-term froth building in stocks at this swing target level. If there is a pullback into late June, as per Seasonals, then we would target a 3 to 6% downside buying opportunity before the uptrend resumes.

Since Nvidia broke out at 305 on May 25th and Apple above 175, we have discussed these stocks as a proxy for the tech market, providing a new floor of support for the general stock market. When the Artificial Intelligence (AI) gold rush was kicked off by Nvidia’s massive upward revision in orders and revenues, it created a large gap opening on its price chart that was unlikely to be filled until buyers pushed up prices to create room for profit taking. Now that the $1 trillion milestone for Nvidia has been reached, there is space for a modest correction in this stock and the Tech cohorts it leads. Nvidia has support near 400 this month and the mid 300’s longer term. Apple has a magnetic attraction for investors at a $3 trillion valuation – 190’s basis its stock price. Watching the action of these market leaders should provide a clue as to how the overall market will behave and when optimism has rebounded too far.

In what appears to be the early innings of a new Bull market, we see that after more than a year of extreme pessimism among money managers and investors, a sunnier disposition is resurfacing. Now that the headlines have proclaimed that the 20% rally from the October low ushers in a new Bull market, it will soon be time to look for a medium term exit this summer. The Summer peak we have expected – ideally late July – should eventually devolve into another downside scare this Fall as the economy flattens and AI mania retreats from its artificial forward valuations. 

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