Edison Byzyka, CFA and Alisha Norris, CFA discuss the historic performance of markets with a negative sentiment.
2022 has been a tough year for investors with both stocks and bonds down sharply from recent highs. Add to that decades-high inflation, an aggressive Federal Reserve, COVID-19 restrictions, and the ongoing war in Ukraine, it may come to no surprise that consumer sentiment is showing signs of pessimism. The University of Michigan Consumer Sentiment Index, which surveys consumers to measure attitudes toward personal finances and general business and market conditions, is currently at historic lows, surpassing levels hit during the COVID-19 pandemic and Global Financial Crisis. We argue that the level of extreme pessimism is overdone. A strong labor market, pent-up demand, and healthy household balance sheets should continue to support consumption, allowing for sustained economic growth. Given these underlying strengths, we view current sentiment data as a contrarian indicator and see notable opportunity for sentiment improvement in the second half of the year.
Historically, extreme investor pessimism has been a strong contrarian indicator for above-average short term stock market returns in the months that follow. To reach this conclusion, we looked at past troughs in the University of Michigan’s Consumer Sentiment data going back to 1978 and subsequent 3 month, 6 month, and 12 month returns for the S&P 500 Index. When consumer sentiment bottomed in prior market cycles, forward 3 month returns averaged over 7% with 88% of occurrences providing a positive return, forward six month returns averaged over 13% with 100% of occurrences providing a positive return, and forward 12 month returns averaged over 22% with 94% of occurrences providing a positive return.
Overall, our assessment is that the level of extreme pessimism is unjustified, providing a strong contrarian indicator that positive equity returns may be in store in the months ahead.
The opinions voiced in this material are for general information only and are not intended to provide specific advice or recommendations for any individual. All information is historical and there is no guarantee of future results. All indices are unmanaged and may not be invested into directly. No strategy assures success or protects against loss. Stock investing involves risk including loss of principal. The economic forecasts set forth may not develop as predicted. To determine which investment(s) may be appropriate for you, consult your financial advisor prior to investing. Investment advice offered through CX Institutional, a Registered Investment Advisor.