Last summer, I paused to reflect on the long, strange journey of today’s market environment, invoking the words of the Grateful Dead in their bluesy anthem, Truckin’. This month, I veer from counterculture rock lyrics to the soulful incantations of Otis Redding, who poignantly captures what feels like the prevailing market sentiment: “I’ve been loving you too long to stop now.”
True, in the last three weeks we’ve experienced the first real volatility since early 2016, which has been a much-needed reminder that extended tranquility is not the norm for financial markets. But my fear is that with the indexes already having regained over half their losses, too many investors are still unwilling to end their love affair with the nine-year-old U.S. bull market.
To understand the acute cases of equity addiction gripping investors today, it’s helpful to first view the world through the eyes of the afflicted. The S&P 500 hasn’t experienced a down month in 15 months — an unprecedented winning streak — although at -3% as of this writing, it seems probable that February will break that streak. The S&P is still up over 18% in the last year and has averaged almost 15% over the last five years. The magnetic vortex of the Vanguard Group, with its nearly $5 trillion in assets under management, testifies to the massive popularity of passive funds, and with those kind of recent returns, it’s not hard to understand the appeal.
Even though the past few weeks have shaken people out of the mental complacency bred by seemingly easy, low-risk returns, it remains to be seen whether they will vote with their dollars or settle back into the status quo. Either way, the market is no less expensive than it was a month ago, and I see correlations between today’s dangerously high metrics and future volatility.
People’s feelings toward the economy are still overwhelmingly positive, as demonstrated by recent 17-year highs in the ongoing consumer sentiment surveys conducted by the Conference Board and the University of Michigan, and a 31-year high in the AAII Investor Sentiment survey (bulls now outnumber bears nearly 5 to 1). Historically, extreme levels of confidence from investors and consumers have been a contrarian indicator.
Additionally, we see a widening gap between rising consumer sentiment and a declining personal savings rate, a divergence that in the past has served as a precursor to the end of the economic cycle. As we near economic and cyclical peaks, people become more confident about the direction of the economy, leading them to consume more and save less. At the December reading, Americans were only saving 2.4% of their disposable income, the lowest level on record except for a brief period in 2005. Saving, or holding cash, often feels counterintuitive to investors when housing prices and portfolio values are rising, but it’s precisely the defensive position I would argue such expensive market conditions demand.