Sentiment Indicators Improving
Investors looking to gauge market sentiment should consider the opinions of investment newsletters, the optimism of consumers, and the expectations of Wall Street analysts. At the moment, all three indicators are sending at least slightly encouraging signals.
Not surprisingly, bullish sentiment among investment newsletters waned as stocks fell sharply in late April and May. According to Investors Intelligence, 38.5% of the newsletters were bullish as of June 9, versus 31.9% bearish. The difference between bulls and bears — 6.6% — is less than one-fourth of that seen just five weeks ago.
Historically, periods when bulls outnumber bears by at least 30% — as they did in April and early May — have been a dangerous time to buy for stocks. Over the last 10 years, the bull-bear spread has averaged 19%, and Investors Intelligence said the current spread is “close to bullish levels” for stock investors.
Signal: Moderately encouraging. The current spread of 6.6% between bulls and bears is the long-term average. In general, a high level of bearishness is encouraging for stocks.
Two of the most well-known measures of consumer sentiment are up sharply from lows in early 2009. But both the Conference Board Consumer Confidence Index and the University of Michigan Consumer Sentiment Index remain below long-term averages, suggesting consumers have only partially bought into the economic recovery.
Consumer sentiment is strongly correlated with growth in gross domestic product. For example, GDP tends to rise after periods when the University of Michigan Consumer Sentiment Index rises. However, the correlation between consumer sentiment and changes in stock prices is not as strong.
While the recent gains in consumer confidence look like good news for for GDP growth, consumer optimism alone is rarely enough to move the stock market.
Signal: Slightly encouraging.
Consensus estimates for S&P 500 Index companies project profit growth of 33% for the index in 2010 and 18% in 2011. Estimates have trended upward for most of the last nine months. Since Jan. 1, the profit estimate for 2010 has jumped 46% while the 2011 consensus has risen 31%, with most of the gains in the first three months of this year.
The aggressive growth of profit expectations this year bespeaks a noticeable rise in confidence in the wake of a rough 2009. Increases in profit estimates have slowed in the last two months, but targets continue to move slightly higher.
While the magnitude differs, all three sentiment indicators discussed above are at least slightly encouraging for stock investors. The rising bearishness among newsletter editors is a positive for stocks, and while consumer sentiment remains below long-term norms, it is trending higher. In addition, profit-estimate trends suggest Wall Street analysts are becoming more optimistic about the future. However, sentiment — like the stock market — can change directions quickly. Complacency is dangerous, and the wise investor will keep his finger on the pulse of the market and its various constituents, prepared to alter course should conditions demand it.