INSIGHTS

On December 30, 2014

Sentiment and Seasonality: A Prominent Direction Revealed for 2015

Consumer, business and investor sentiment have all been quite sedated throughout the economic recovery.  Heading into 2015, we look at a multitude of sentiment indicators to get a general sense of whether the compass is pointing to a negative, neutral or positive bias.

• The University of Michigan Consumer Sentiment Index currently stands at 93.6, a post-recession high from it’s all time low in 2008 of 55.3.  Still below its all-time high of 112 in 2000.
• The NFIB Small Business Optimism Index is similar in its ascent to that of the consumer sentiment number.  It currently is at a post-recession high of 98.1.
• The United States Misery Index, as calculated by Bloomberg, is well off its all-time high set in 2011 and is well below its long-term average.
• The percentage of U.S. senior loan officers being more restrictive in their lending standards for business loans has been near its bottom historical range, indicating more propensity to lend than to not. 
• Morgan Stanley’s Business Conditions Index rose dramatically in December with increases in Capex plans and current hiring while plans for hiring in the future and advance bookings fell.  Still slightly positive in all.

The economic sentiment indicators point to more positive expectations, which is positive for the economy in the intermediate time frame.

For investor sentiment indicators, we tend to find a lot more divergent opinions.

• Merrill Lynch Bank of America’s sell side indicator is still one of the best predictors of future market movement by measuring Wall Street’s analysts sentiment.  It is still in very bearish territory which denotes a buy signal and is a twelve month return in the S&P 500 of 20+%.
• Citigroup’s Panic Euphoria model is right smack dab in the neutral category. 
• Merrill Lynch’s Global Fund Manager Survey showed yet another month of managers holding excess in cash which denotes a contrarian buy signal.  In fact, the entire calendar year of 2014 showed a bullish buy signal as cash remained elevated the entire year.  The three biggest risks was geopolitical crisis, Eurozone deflation and China debt defaults. 
• The CNN Fear Greed Index lay in the neutral area.  One month and one year ago it was reading greed.  This is a contrarian indicator where greed would be bearish and fear would be bullish.
• The indicator that those who are calling for substantial market exuberance is the American Association of Individual Investors which denotes that members who voted are 50.9% bullish versus the long term average of 38.9%.  Conversely, only 18.9% are bearish versus the long-term average of 30.4%.  The relevancy of this indicator as a contrarian indicator is debatable in the methods with which the data is obtained, the variance in the results weekly and the profile of the investor.  Still, we would be remiss if we didn’t at least mention it. 
• Fund flows showed influx into domestic equity funds and fixed income while money markets and precious metals saw outflows.  Nearly all inflows were into exchange traded funds versus mutual funds.  According to Merrill Lynch, we saw 51 straight weeks into Investment grade bond funds while there were 14 straight weeks of outflows from Treasury Inflation Protected Securities.
• The last, and one that is perhaps more an enigma, is the NYSE margin debit balance which has been hovering near all-time highs since February.  This would normally be a signal for being cautious, but when one considers the large degree of liquidity in household balance sheets, low lending rates at the margin level, and that it has been at these elevated levels for nearly a year, one must think there is a bit more going on.  Remember that to short the market requires margin and quick degree of getting loans for other purchases at low rates relative to the process in traditional banking could be adding to this.  In the past, when these high water marks denoted market tops in 2000 and 2007, they spiked and didn’t hover. 

There are also three large seasonality-type patterns that should be addressed.  Two have to do with politically-driven historical patterns while the last (and perhaps most significant) is correlation-based. 

As noted in the chart, the six months following midterm elections are typically robust, and are even more so when it falls into the second term of a sitting President. The total return for the Russell 3000 Index for those six months stood at 13.80%. However, returns for the following six months are historically lower at 8.33% at year-end.

The third year of the Presidential Cycle, which will be 2015, is also the most robust year of the four-year cycle. 

Perhaps most important is the alternating relationship of annual returns in the S&P 500 Index and Russell 2000 Index relative to returns in long-dated Treasuries.  When we look at annualized returns of the long end of the Treasury curve compared to the Russell 2000 Index and S&P 500 Index, correlation and volatility show some slight pattern shifts from 1990-2002 and 2003-current.  However, the math behind it is only slightly correlational.

What is of particular interest over this period is what occurs the year after the long end Treasuries has a 20+% total return and what occurs in the corresponding equity indexes.  The chart doesn’t reveal as much as the data analysis does. 

In 1995, 2000, 2008 and 2011, the Long Treasury returned over 20% (averaged 26%); the next year the long end averaged a return of -1.51%.  The average annual return over this time frame for the Long Treasury was a total annualized return of 9.07%.  During these years, the Russell 2000 Index averaged an annual total return of -4.56% while the S&P 500 Index generated an average of -1.6%.  It seems the “W” chart pattern that the Treasury return displays may stand for “watch out” in the coming year.

The years following (1996, 2001, 2009 and 2012) abnormally high Treasury returns, the Russell 2000 Index had an annual return of 13.91%, 37% higher than its average since 1990.  The S&P 500 Index averaged a 13.14% annual return, an 18% increase over its average since 1990. 

Sentiment and Seasonality continue to point to more bullish equity and economic growth in 2015.

CRN: 2014-1208-4552 R

AAM was not involved with the preparation of the articles linked to in this email and the opinions expressed in these articles are not necessarily those of AAM.