Why are investors so glum?

Investors are not excited about stock investing right now. In the September 15, 2016, sentiment report by The American Association of Individual Investors, they found the following:

  • 27.9% of investors were bullish on the market moving higher (versus a long-term average of 38.5%)
  • 36.1% of investors were neutral on the market (versus the long-term average of 31.0%)
  • 35.9% of investors were bearish and felt the market would head down (versus the long-term average of 30.5%)

Investors truly have a lot of uncertainty to deal with, but one of those concerns shouldn’t be market optimism. With current bullish sentiment well below its historical average, this isn’t the typical behavior we see before a major market decline. Historically, when sentiment is high and investors are excited about investing, that is usually a sign that market prices may be ahead of themselves, and vice versa. Looking back at the last two major market highs of 2000 (the dot com bubble) and 2007 (the financial crisis), we can see that investor sentiment was very high during those times. Bullish sentiment in March of 2000 was as high as 65.7% and as high as 54.6% in October of 2007. We are far from those levels today even though we are near all-time market highs.

While there are a number of reasons that investors are glum about the stock market, here is our take on why investors are apprehensive right now:

  1. Macro Risks: In the age of the 24/7 news cycle, it seems like big risks just keep getting bigger. According to the September 2016 BofA Merrill Lynch Global Fund Manager Survey, the biggest concerns on professional investors’ minds right now are a European Union disintegration (i.e., the EU breaks up) and a Republican winning the White House. Regardless of the odds, both of these scenarios would produce uncertainty in some form. However, the stock market has a history of dealing with uncertainty. While these shocks may cause negative, short-term reactions, history has shown that these impacts don’t last.
  2. Central Bank Policy: Global central banks have been trying to stimulate economic growth in some form since the Great Recession. Their main tool has been lower interest rates. While lower interest rates makes borrowing more affordable, it also lowers the amount of money savers receive from their investments. That means that people have less interest income to spend and they have to save more to enjoy a comfortable retirement. These trends are part of the reason we are not seeing higher economic growth in the U.S. and elsewhere. In the U.S., our central bank is attempting to slowly raise interest rates and around, while central banks around the world are calling for governments to try and pass fiscal stimulus.
  3. Valuations: Low interest rates have pushed investors toward stocks during a time when the average company is making less money than it did a year ago. This means that valuation metrics like the Price-to-Earnings ratio look high and that makes investors uncomfortable. Fortunately, the decline in earnings appears to be near an end and companies are expected to experience earnings growth in the next quarter or two (source: FactSet)

In our mind, the use of broad diversification remains a valid strategy for managing these risks and others.