December 20, 2020

The Downside of Optimism

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Bottom Line:


The market’s current high level of bullishness has us tempering our own. We believe strongly that this market will climb substantially higher into 12/31/2022 thanks to highly favorable fundamentals. However, in the short run, overly-bullish sentiment readings require deflating. We would prefer a sharp correction to reset sentiment quickly but see no obvious catalysts. Instead, markets may just idle here as cash levels rebuild while earnings backfill lofty valuations. We may have already begun this process as the indices have captured new highs(!) while trading nearly unchanged over the last two weeks. For those with year-end cash to invest, now’s the time to spread purchases out over a couple months and average into cost basis. But stay sharp! Should a rapid sell-off occur, use the opportunity to accelerate your acquisitions. OR… just call us. We would be happy to do it for you!


The Full Story:


As Benjamin Graham famously quipped (according to Warren Buffett), “in the short run the market is a voting machine, but in the long run it’s a weighing machine.” To translate, over longer periods of time, fundamentals like economic growth rates, interest rates and corporate earnings determine price levels. Over shorter periods of time, tastes and preferences determine price levels. Despondent investors tend to underprice assets (see March 2020), while euphoric investors tend to overprice assets. Consider Snowflake, one of the top vote-getters of the “ stay-at-home trade” that has cat nipped euphoric investors this year. Snowflake provides data management and analytics services on a SaaS platform within the cloud. I’m not sure what that means, and most investors probably don’t either, but it sounds exciting! So exciting, in fact, that Snowflake has a $100 billion market cap with only $500 million in sales. Therefore, the company trades at 200x revenues vs. roughly 2x for the S&P 500. Maybe Snowflake should rival IBM’s market cap, even though IBM has $75 billion in sales… but maybe not. Only time will tell. The point is enthusiasm and euphoria can push prices up to dizzying heights. With markets trading at all-time highs, has the market reached such a point overall?


The Investors Intelligence Sentiment Index provides weekly insight into the bullishness of an index of newsletter writers, a proxy for “professional” investors. Those of you who follow our commentary know that we have been resolutely optimistic about the prospects for this market throughout the COVID crisis. In fact, we saw COVID as a catalyst for unprecedented monetary and fiscal stimulus that would ultimately mix with post-vaccine animal spirits to drive markets to all-time highs. As contrarians by nature, we prefer environments where we hold the minority view. It’s the conversion of the skeptics that brings fresh money in to power markets higher. Better to be early than late in this business! Unfortunately, at the current moment, the Investors Intelligence Sentiment Index reports professional investor bullishness near historic highs:



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The historic returns that tend to follow readings of this elevation are disappointing:


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Clearly, our contrarian thesis plays out. Higher sentiment readings produce lower forward returns just as lower sentiment readings produce higher forward returns. When bullishness has risen to between 60-70%(as it has 170 times in the past), forward returns have been positive… but meager.


We also track the American Association of Individual Investors sentiment survey. This index polls “amateur” investors who have viewed the COVID rise with a higher degree of skepticism than the professional investors… providing us some contrarian comfort. Recently, however, amateur investors have become more bullish as well. AAII bullishness recently hit 56%, while bearishness dwindled down to 25% (the remaining respondents were neutral). High levels of professional investor bullishness matched with high levels of amateur investor bullishness suggests full equity allocations and diminished cash piles. Without stockpiles of latent cash, stock prices should struggle for advancement. Bespoke Investment Group combined both the professional and amateur indices to enhance their predictive power:


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Once combined, we find current sentiment levels in the top 4% of the 1688 surveys counted. Forward returns, while positive overall, remain meager and even more so, with the S&P 500 returning less than 1% over the next twelve months.


Have a great weekend!



David S. Waddell 
CEO, Chief Investment Strategist




Sources: Bespoke Investment Group
David Waddell
Author: CEO Chief Investment StrategistAfter graduating from the University of the South with a BA in Economics, David began his career with Charles Schwab & Co., Inc. in Phoenix, AZ. Having been recognized for his outstanding business development record, David was promoted to the San Francisco- based Institutional Strategic Accounts Team, which interfaced with the Big 5 accounting firms and Schwab’s largest customers. David left Schwab to continue his education at the graduate level in Boston. While earning his MBA degree with a concentration in finance and investments at the F.W. Olin School at Babson College, he was appointed by the college Trustees to manage a team of seven portfolio managers overseeing the student-managed portion of Babson’s endowment fund. David also founded the Babson Investment Management Association to assist undergraduate and graduate students with training and career path planning in the investment management field. As the firm’s Chief Investment Officer, David chairs the W&A investment committee and combines macro economic forecasting, macro market analysis and macro risk assessments to design portfolio strategies utilizing public market securities worldwide. A civic leader in Memphis, David currently acts as Chairman of Epicenter Memphis, and Co-Chair of the Memphis Chamber Chairman’s Circle while also serving as a board member for LaunchTN and the New Memphis Institute. David previously served as chairman for The Leadership Academy, the RISE Foundation, and the Economic Club of Memphis. He also chaired the capital campaign to build the “Live” stage at the Memphis Botanic Garden. David was a member of the 2004 Leadership Memphis class and has been recognized as one of Memphis’ “Top 40 under 40” by the Memphis Business Journal, and as a finalist for “Executive of the Year” in 2007. In addition to weekly columns in the Memphis Daily News and the Nashville Ledger, David has appeared in the Wall Street Journal, USA Today, Forbes, Business Week, Investment News, Institutional Investor News, The Tennessean and Memphis Business Journal. He has also made appearances on Fox Business News, Yahoo Finance, Bloomberg TV, CNBC, and CBS News and ABC News Channels. Read some of David's articles on his author page in Inside Memphis Business. David has two wonderful children, Easton and Saylor, an obedient Labradoodle named NASDAQ, and a devoted Goldendoodle named Ripley.


David S. Waddell


Chief Investment Strategist

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