Equity Sentiment Extreme: Reduced U.S. Equities Rating

Investing Environment Review and Outlook – Volume 34

Equity Sentiment Extreme: Reduced U.S. Equities Rating

We cut our U.S. equity ranking to a neutral 3 from a bullish 5 due to extreme sentiment readings. Although economic conditions, marked by moderate growth, a loose Fed, and low inflation remain positive for equities, investor sentiment reached a 2-year extreme following the steady 13% S&P 500 advance since October 3rd. 6 of 10 investor groups are extremely optimistic, our best indication investors as a group have less cash to drive stocks higher. In prior cases, with such optimism at year-end, the S&P 500 declined 5-10% in January or February. For instance, when sentiment was this extreme in late 2017, the S&P 500 peaked on 1/26/18 and declined 10% in February. Other cases were followed by smaller declines of 5-6% in January 2011 and January 2014. For comparison, on October 8th this past fall, before the 13% move in the S&P 500, equity sentiment was the mirror image of today, with 6 of 10 groups showing extreme pessimism.
We also reduced developed foreign equities to a bullish 4 rating from 5 due to the risk they could be pulled lower if the S&P 500 declined. Emerging markets equities remain a max bullish 5 rating with sentiment less of an issue in our opinion, and due to the compelling 28% valuation discount to the S&P 500.

Increased Commodity Rating

We increased the commodity rating to a bullish 5 from a neutral 3 due to strong economic outlook indicators and a weak dollar. Our economic outlook model improved to 71, which historically indicates the likelihood that the U.S. economy will accelerate in the next 3-6 months. It is also a good indication of potential commodity strength ahead, in particular crude oil. For instance, as you can see on chart 2, when readings were over 60, crude oil returned 34% annualized since 1990, 8x the norm. Economic strength may have an even bigger effect on prices this year since expectations are so low. For instance, consensus for 2020 GDP is just 1.8%, down from 2.3% expected for 2019. After rallying through September, the dollar declined 3% in Q4. Since 1990 when the dollar was declining, crude oil returned 17% vs. a -7% return when the dollar was rising. Since crude oil and many other commodities are priced in dollars, when the dollar declines, commodity prices typically go higher.
The addition of crude oil to a traditional equity portfolio might sound risky, but with a correlation of just 0.36 with the S&P 500, crude oil can actually cut the volatility and risk of a portfolio since moves in each may offset each other. And given the biggest risk to equities is inflation, a combination of gold and crude oil generally serve as an effective inflation hedge.

Increased Gold Rating

We also increased the gold rating to a bullish 4 from a neutral 3, based on inflation and the Federal Reserve. Since 2000, gold returned 14% annualized when the Federal Reserve was easing rates and CPI inflation was rising, conditions we have today. This is significantly better than the norm of just 8.7% over the same period. CPI inflation was 0% in 2014 after the price of oil collapsed and has since risen to 2.1%, and likely 2.3% through December. At their December meeting, the Fed said they would allow inflation more leeway to the upside before tightening policy, an extremely bullish development for gold. With a strong economic outlook and commodities like crude oil and copper rising already, a risk for this bull market is unexpected inflation. Investors will likely continue buying gold to hedge this risk, particularly with the Fed signaling they will not tighten anytime soon.

In summary, background conditions remain bullish for stocks with moderate growth and strong Fed support through 3 cuts and $50 billion per month of T-Bill purchases. However, the higher expected volatility in January combined with extreme sentiment readings were enough to cut our U.S. equity and developed equity ratings until conditions improve. We also raised commodity ratings based on the improving economic outlook and rising trend of inflation, ultimately the biggest risk to any bull market. Thank you for your support and please contact your advisor with any questions or to discuss if changes are warranted in your portfolio.

IMPORTANT DISCLOSURES

This review and outlook report (this “Report”) is for informational, illustration and discussion purposes only and is not intended to be, nor should it be construed as, financial, legal, tax or investment advice, of Brenton Point Wealth Advisors LLC or any of its affiliates (“Brenton Point”). This Report does not take into account the investment objectives, financial situation, restrictions, particular needs or financial, legal or tax situation of any particular person and should not be viewed as addressing any recipient’s particular investment needs. Recipients should consider the information contained in this Report as only a single factor in making an investment decision and should not rely solely on investment recommendations contained herein, if any, as a substitution for the exercise of independent judgment of the merits and risks of investments.
This material is based upon information obtained from various sources that Brenton Point believes to be reliable, but Brenton Point makes no representation or warranty with respect to the accuracy or completeness of such information. Views expressed herein are current only as of the date indicated and are subject to change without notice.
This Report contains certain forward looking statements opinions, estimates, projections, assessments and other views (collectively “Statements”). These Statements are subject to a number of assumptions, risks and uncertainties which may cause actual results, performance or achievements to be materially different from future results, performance or achievements expressed or implied by these forward looking statements and projections. Brenton Point makes no representations as to the reasonableness of such assumptions or the likelihood that such assumptions will coincide with actual events and this information should not be relied upon for that purpose. Changes in such assumptions could produce materially different results. Past performance is not a guarantee or indication of future results, and no representation or warranty, express or implied, is made regarding future performance of any financial instrument mentioned in this Report.
Any benchmark shown herein is shown for illustrative purposes only. No index benchmark is available for direct investment. It may not be possible to replicate the returns of any index, as the index may not include any trading commissions and costs or fees, may assume the reinvestment of income, and may have investment objectives, use trading strategies, or have other materials characteristics, such as credit exposure or volatility, that do not make it suitable for a particular person. This is not an offer or solicitation for the purchase or sale of any security, investment, or other product and should not be construed as such. References to specific financial instruments and to certain indices are for illustrative purposes only and provided for the purpose of making general market data available as a point of reference only; they are not intended to be, and should not be interpreted as recommendations to purchase or sell such securities. Investing in securities and other financial products entails certain risks, including the possible loss of the entire principal amount invested, as the value of investment can go down as well as up. You should obtain advice from your tax, financial, legal, and other advisors and only make investment decisions on the basis of your own objectives, experience, and resources.
Brenton Point accepts no liability for any loss (whether direct, indirect or consequential) occasioned to any person acting or refraining from action as a result of any material contained in or derived from this Report, except to the extent (but only to the extent) that such liability may not be waived, modified or limited under applicable law.
This Report may provide addresses of, or contain hyperlinks to, Internet websites. Brenton Point has not reviewed the linked Internet website of any third party and takes no responsibility for the contents thereof. Each such address or hyperlink is provided solely for your convenience and information, and the content of linked third party websites is not in any way incorporated herein. Recipients who choose to access such third-party websites or follow such hyperlinks do so at their own risk.
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Source of data and performance statistics: Bloomberg L.P. and Factset Research Systems Inc.
©Brenton Point Wealth Advisors LLC 2020

Brenton Point - Careers

Michael Schaus

Director of Market Research

Michael Schaus is the Director of Market Research for Brenton Point Wealth Advisors and Zweig-DiMenna. Since joining Zweig-DiMenna in 1992, his focus has been on macroeconomic research, the analysis of…

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