Déjà Vu, With A Twist
February 2019
As of January 31, the S&P 500 had climbed 15.2% since the day before Christmas, and 8% in January, while domestic small-caps fared even better, with the Russell 2000 rising 18.5% from 12/24 to month-end, and 11.2% in January. It’s admittedly much easier to say in retrospect than in the moment, but the late-December selloff was overdone. January’s rebound has evolved into more than a mere snapback from oversold conditions as investors have ultimately received some much-needed positive news. Market participants appear more at ease with regard to FOMC policy on the heels of the Committee’s January meeting, while institutional investors have increased equity exposure via portfolio rebalancing during the month, allowing fund managers in cash-raising mode amid outflows in December to deploy dry powder into their highest conviction ideas. No matter the root cause(s), a great many things broke the right way to drive the best January performance for the S&P 500 since 1987.
One need only look back to last year when seeking out parallels for January’s market move. Entering 2018, tax reform had just passed and animal spirits were on full display as the S&P 500 moved higher on a seemingly daily basis amid low volatility. The S&P 500 rose 7.5% over the first four weeks of 2018, an eerily similar return outcome versus the past month, before surrendering those gains, plus some, over the following two weeks. Maybe it’s that we’ve been inundated on a daily basis with negative market commentary or dire prognostications for market returns, but this past month’s rebound felt very different to us than it did last January prior to the selloff. In a complete 180-degree shift from last January, and despite the past month’s equity market rebound, pessimism continues to dominate the daily news feed, and, in turn, investor psychology.
December’s American Association of Independent Investors (AAII) Asset Allocation Survey pointed to a cash allocation of 21.8%, a jump of 2.1 percentage points month-over-month and the highest level since March of 2013, while exposure to stocks and stock funds fell to 62.4% from 64.6% the prior month, the lowest level since February of 2016. Notably, February 11th of 2016 marked the lowest close for the S&P 500 within the past 5 years as the price of crude oil plummeted into the mid-$20’s per barrel on global growth fears – the S&P 500 is up 45% in price, and 54% on a total return basis since. In the last weekly AAII Sentiment Survey completed in December, investor pessimism reached its highest level in five and a half years, a reading taken as a strong contrarian buy signal, judging by January’s subsequent rally.
The most dangerous words in investing, “this time it’s different,” come to mind after January’s move, but pessimism in 2019 appears to have replaced early 2018’s optimism, a decidedly positive shift for bulls. From a contrarian perspective, this pessimism provides the potential for further equity gains, albeit with heightened volatility, this year as reluctant bears may be quick converts to the bull camp as layers of uncertainty are removed from the equation. We’re on the lookout for signs of excessive optimism, which would be one potential catalyst to alter our overweight position in stocks. While we remain constructive on equities at present, we would take a page from the FOMC and note that data in the coming weeks and quarters will be critical.
Sir John Templeton famously stated, “bull markets are born on pessimism, grown on skepticism, mature on optimism, and die on euphoria. The time of maximum pessimism is the best time to buy, and the time of maximum optimism is the best time to sell.” On the continuum Templeton laid forth, we’re presently somewhere between these two extremes after January’s rebound. Being contrarian is rarely comfortable, and we don’t want to be contrarian simply for the sake of being contrarian, but this approach can serve an investor well if pursued with open eyes and ears.
Source: AAII, Bloomberg, Factset
