What a ride it’s been for US stocks since the US presidential election.
From fear to feverish optimism, investors have been buying stocks with gusto, adopting the view — somewhat belatedly in many cases — that Donald Trump will deliver a boon to US corporate earnings when he is sworn in as the next US president on January 20.
From the low of November 9 — the day after the election was held — the Dow Jones Industrial Average (DJIA) has put on nearly 9%, extending the cyclical bull market for the index into a 93rd consecutive month, the third longest on record.
It’s clear that many investors believe Trump will truly make America great again, and deliver further strong gains for stocks in the process.
This chart — among many — underlines the shift in investor sentiment that has been seen towards Trump over the past two months.
It shows the US S&P 500 index overlaid against the percentage of stock advisers who are bullish on US stocks looking six months ahead in the weekly AAII investor sentiment survey.
Unsurprisingly, given the move in stocks over the past two months, bullish sentiment is marching higher, mirroring similar moves in other sentiment surveys along with measures on expected market volatility.
According to Michael Riesner and Marc Müller from the UBS equity sales and trading team, the recent post-election rally has pushed almost all of its sentiment studies into contrarian territory, suggesting not only is investor complacency high at the start of 2017, but market positioning is also increasingly one-sided.
“We are starting 2017 with a very one-sided investor sentiment, where the percentage of neutral investors in the AAII survey collapsed from last year’s record level to the lowest reading of the last 4 years,” the pair said in an email sent to clients earlier this week.
“So from last year’s record uncertainty we have seen a super sharp swing in the investor sentiment towards a very decisive bullish conviction.”
This overly bullish view, the pair says, will likely prove to be troublesome to further substantial market gains, and increases the risk of investor disappointment should Trump be unable to deliver faster economic growth, increased inflationary pressures and higher US interest rates.
“Extreme bullishness in combination with high conviction is contrarian and suggests a high risk to see negative surprises in 2017,” say Riesner and Müller.
“It can mean that the markets have priced in too much and if the fundamental world does not deliver we will see mean reversion corrections or see the described reflationary overshooting where sharp moves on the FX side and in bonds are choking off any improving factor on the economic side.”
It’s a classical contrarian view — be fearful when others are greedy and greedy when others are fearful — but one that Riesner and Müller don’t believe investors should adopt, at least not yet.
“We do not think that investors are already this kind of over-invested that we generally need to get worried about the market. Even in the cyclical key themes such as banks, where we saw a massive rally in Q4, we don’t think that investors are really overinvested,” they wrote.
“However, in later Q4, we have clearly seen investors chasing the market so the herd is obviously running and this is a process we expect to continue into summer (southern hemisphere winter).
“If we are correct with this call, we could move into a sentiment setup where in summer we get the real contrarian setup, where positioning and ‘talking’ finally fits together.”
Nearer-term, Riesner and Müller see a tactical correction for US stocks in Q1 before the market makes yet another push higher into the northern hemisphere summer.
“It does not matter whether we look at the volatility which is at a 4-year low, the SKEW/VIX ratio or the CBOE put/call ratio, all our tactical sentiment measures are at extreme levels as well, which suggests that very soon in January the air will be getting thin for the market,” they wrote.
This post has been updated to clarify that the views expressed by Riesner and Müller are their own, and do not reflect the UBS house view.
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