A Skeptical Pull

Sentiment can tell us a lot about the ongoing bull market. We often quote Sir John Templeton’s famous proverb, “Bull markets are born on pessimism, grow on skepticism, mature on optimism and die on euphoria.” These days, sentiment is playing a fairly evenly matched game of tug-of-war between stubborn skepticism and tenacious optimism. How long it lasts, only time will tell.

While we generally don’t put much stock in sentiment surveys, one recent poll caught our eye as an interesting illustration of sentiment’s ongoing tug-of-war: After four and a half years of economic growth and nearly five years of bull market, about six in 10 Americans polled think the US is still in recession—only somewhat improved from mid-2010, when 70% felt that way (one year into the recovery). 63% think the country is moving in the wrong direction! There’s that sour, dour skepticism! But in a bizarre twist, 63% feel good about their personal financial situations, and 35% believe they’ll keep improving—up from 29% last summer. A sunnier outlook! It’s almost a perfect statistical reflection of evolving sentiment where folks think, “I’m ok, but most everyone else isn’t.”

If this seems weird, that’s because it is. If we were actually in a recession, many wouldn’t feel so great about their finances—money would be tighter, job prospects iffier, portfolios probably leaner. Most would be worried about their personal future. That they aren’t, on balance, should be evidence enough that the broader economy is doing fine. But when headlines persistently tell you otherwise, warning of a (misperceived) manufacturing meltdown in the US and China and turmoil in Emerging Markets, it’s all too easy to suspect your own improving situation is an outlier. Folks are trying to be optimistic, but the skeptics are tugging hard.

This battle of will between emotions has lasted a while. It flared up big time late last year as investors tried to interpret the rise in IPOs and a few high-flying offerings. These very things were signs of budding optimism—investors, firms and underwriters had faith in markets and were willing to take more chances. But many didn’t see it this way. They instead found the influx of IPOs distressing, fearing the “glut” of new public offerings signaled euphoria, and a bear was nigh—they saw a repeat of 1999 and 2000. This was a flawed interpretation, in our view. For one, if euphoria were rampant, few would have noticed in their frenzy to buy, buy, buy! Two, 2013’s 130 IPOs were far from booming. In the late 1990s and 2000, there were around 8,000 stocks listed in the US. By 2012, US listings fell to 4,916—a 45% decline. New offerings, too, were well off levels seen in 1999 and 2000. 2013 was the first year US stock market listings rose since 1999, and after netting out IPOs and delistings (mergers, acquisitions, bankruptcies, etc.) only 92 firms were added to US exchanges last year. We are not flooded with equity supply. Nor are investors wildly bidding up IPOs, as they were at the Tech Bubble’s heights. A few outliers aside, most of the IPOs debuting last year finished their first few trading days not far above the offering price. More cautious optimism misinterpreted as euphoria.

The skeptics won that round, and they seem to be tugging harder today. After stocks had a relatively calm, gangbusters 2013, optimism was starting to materialize. But after a rocky January—essentially a return to the normal volatility absent for much of last year—back came the blues and folks’ tendency to minimize good news. US corporate balance sheets are cash-rich, profits are high and businesses are spending on equipment and R&D. The UK grew its fastest since 2007 last year, and firms there can’t keep up with rising demand. Both countries’ Leading Economic Indexes are high and rising. Though the pace may be slower, China is still contributing a ton to global growth and most Emerging Markets are doing just fine. Factory and service activity is on the rise globally, and so is GDP. But most of these stories get buried, while the A-block warns of slowing US exports, fearful investors supposedly flocking from stocks to bonds, a potentially weakening France, a slowing China, and a Fed with its foot on the brake. None of these mean much for stocks globally (except in the Fed’s case, but reducing bond purchases is good, not bad). Since this is an environment where investors are looking for the bad, not the good, most anything people think is dreary will do.

How long skepticism will pull harder, we can’t tell—emotions change unpredictably and often aren’t rational. Were it otherwise, investors would be extraordinary at predicting market’s short-term moves. One thing that could turn the tide, though, is a correction—a quick drop of 10% to 20% or so over a few weeks or months. (Perhaps that has already begun, though you can only truly tell with hindsight.) Maybe that seems backward, but many skeptics won’t convert until their fears seem assuaged or acknowledged—it would confirm their fears were right and justified. If stocks drop quickly, pessimists can believe Emerging Markets/China/the Fed/(insert long-held fear here) finally had the big impact they dreaded. And then, they can believe the worst is officially over, and their sentiments can lift along with stocks’ recovery.

This isn’t a given, of course. We might not even have a correction. We’ve had five in this bull market but didn’t last year. Perhaps instead the media changes its tune and starts looking for good instead of bad. Maybe one outlet tries to gain attention with a fresh, positive perspective and more follow. Whenever and however optimism eventually does pull harder, though, more confident investors should help drive this bull to newer, even higher heights.