Momentum vs sentiment
Market rule number one: be fearful when others are greedy. Market rule number two: don’t bet against momentum. Good rules to follow, but right now they conflict.
We’ve discussed sunny sentiment several times lately. Our go-to measure, the net bullishness among investors surveyed weekly by the American Association of Individual Investors, has been consistently positive all year:
In the past week, moreover, Citi’s Levkovich index has moved into “euphoria” territory, which has historically preceded periods of subpar returns. This is a broad measure of sentiment, pulling together indicators from across several markets. What tipped the index euphoric, notes Scott Chronert at Citi, was limited options hedging and rising margin debt:
Next, momentum. There are many sophisticated indicators of momentum, but delving too far into technical analysis is treacherous (for us, anyway). We prefer keeping it simple, by comparing an index’s recent performance to its 200-day moving average, which is supposed to capture how concentrated buying or selling has been. As of Monday, the S&P 500 was 14 per cent above its 200-day average:
This is high. The chart below visualises the strength of recent momentum against 80 years of S&P 500 performance, though using weekly rather than daily data. For the past two months, the S&P 500 has traded about 15 per cent above its 52-week moving average. That is in the top decile of historical momentum, as you can see in the chart:
Euphoric sentiment urges caution, but strong momentum suggests investors should let it ride. Which to believe?
The equity strategists we follow have seemed mostly unworried about sentiment. As Chris Verrone of Strategas noted yesterday, rising breadth helps make market euphoria look a bit less scary:
The immediate risk we see is sentiment (i.e., the bar of expectations is high), but so far fatigue in the market’s most pronounced momentum corners has been met with strength elsewhere. Last week was a good example of this . . . the Momentum Factor ETF (MTUM) has stalled, reflecting some modest relative weakening from Tech, but the % of stocks above the 200-day moving average closed at its highest level in about 3 years (85%). In equally-weighted terms, Energy, Industrials, Financials, and Materials actually all outperformed Tech in 1Q — you could probably win a bar bet with that fact.
Remember the backdrop: consistently surprising economic strength. The Citi US Economic Surprise index, which measures how much data beats analyst expectations, has been well into positive territory all year. We got a fresh reminder of this yesterday, with an above-expectations ISM survey showing US manufacturing expanding for the first time in a year and a half. And as Chronert points out, S&P 500 performance this year has been notably correlated with economic surprises (his chart):
The simultaneously strong market momentum and delirious sentiment doesn’t worry us so much — so long as underlying economic growth keeps surprising to the upside. When growth slows, we’ll pick one to follow.