Summary
Included in the daily economic releases around the world are confidence/sentiment indicators. We’ve researched these releases and view them more as measures of emotion rather than anything predictive in nature. Confirming our analysis, other studies suggest that managing an investment portfolio based on emotional highs and lows can actually be detrimental to the long-term performance of an investor’s portfolio.
Below we’ll explain why we don’t assign much weight to confidence/sentiment indicators, and why we believe we’re not in the midst of another 2008 market.
Highlights
- Chart 1 shows a comparison of the Thomson Reuters/University of Michigan index of consumer sentiment (grey) and the price of the Standard & Poor’s 500 (S&P 500) equity index (scarlet). As noted with the light blue and green ovals, this measure of consumer sentiment seems to peak roughly when the market peaks and bottom about when the market troughs. So, if an investor is only fully invested when sentiment is highest, then they own the market when prices are most expensive. Conversely, if investors are getting out of the market when sentiment is bottoming, they have tended to sell when stock prices are cheapest, historically.
- An analysis by DALBAR1 tracked the behavior of individual investors, which is heavily influenced by sentiment. It found that their emotion-driven decisions led to consistent and significant under-performance of benchmarks, often in response to bad news.
- We tend to focus on fundamentals, such as earnings. Chart 2 (the S&P 500 index versus corporate profits as measured by the National Income Accounts) suggests that the recent sell-off in U.S. stocks, while difficult to experience, wasn’t based on the current success of company profits. Quite the contrary. With profits moving to a new record high, and prices recently moving lower, we seem to be far from anything near Buffet’s “cheery consensus” in the market. In other words, the market is negative, yet profits are at record levels. This has traditionally been good for future returns.
Chart 1
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Chart 2
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1 Data taken from 2011 Quantitative Analysis of Investor Behavior, DALBAR, Inc., March 2011
The opinions in this newsletter are for general information only and are not intended to give specific recommendations or advice. Certain information contained herein has been compiled from independent third party sources believed to be reliable. Hamilton Capital Management makes no representation about the accuracy, completeness or timeliness of the information contained herein or its appropriateness from any given situation.