Long-term Sentiment Indicators Suggest U.S. Stock Market Exuberance

Despite Fed tightening, the rise of populism threatening the disruption of global trade and supply chains, along with ongoing delays in U.S. tax reform and infrastructure spending legislation, there is no doubt that economic optimism is more persuasive in mainstream U.S. society today than it was relative to just six months ago. Sure, President Trump is in the process of dismantling Dodd-Frank, the EPA, and even the ACA (through loosening IRS rules on the “individual mandate”) through a series of Executive Orders, but such loosening of regulations is not necessarily bullish for corporate profits as they encourage more competition in such affected industries over time. In fact, loosening IRS rules on the “individual mandate” may even lead to the collapse of the U.S. healthcare system, as the “individual mandate” forms the core of the ACA by requiring young, healthy Americans to purchase insurance so they could subsidize older, less healthy Americans with pre-existing conditions. An ACA in the absence of the “individual mandate” will be credit-negative for most U.S. healthcare companies.

Historically, the Conference Board’s Consumer Confidence Index has not just acted as a reliable, coincident gauge of U.S. consumer sentiment, but also as a very reliable contrarian indicator for U.S. stock prices. While it has always been better in pin-pointing bottoms during a bear market, it has also worked well in calling significant stock market peaks over the last 35 years. This was true in the run-up of both the Consumer Confidence Index and U.S. stock prices leading up to the significant peaks in September 1987, July 1998, Fall 2000, as well as its “rounding top” during the first half of 2007. Just yesterday, the Consumer Confidence Index–by soaring through its September 1987 peak and hitting a high not seen since December 2000–gave us a “strong sell” signal on U.S. stocks. Figure 1 below shows the monthly readings of the Consumer Confidence Index. vs the Dow Industrials from January 1981 to March 2017.

consumerconfidenceSuch extreme complacency among U.S. mainstream society has morphed into “irrational exuberance” as retail investors, aided by near-record-high U.S. corporate buybacks, has also made its mark on U.S. margin debt outstanding. As of February 28, 2017, U.S. margin debt surged to an all-time high of $568.6 billion outstanding, more than $18 billion higher than its previous all-time high of $550.0 billion made in April 2015, just a few months before the onset of the July 2015-February 2016 global equity bear market. Over the last 12 months, U.S. margin debt outstanding has risen by $94.5 billion (see Figure 2 below)–its greatest 12-month rate of margin debt accumulation since June 2014.