Despite sanguine signs, it’s still hip to be a market bear

@ lim_pix - stock.adobe.com

Some fads and fashions just won’t die. This is as true in investing as it is in any other endeavor.

A current investing fad is to be stubbornly bearish. For many professional investors, despite mounting signs that the bear market is on the way out, it’s still hip to be bear — à la the 1986 hit by Huey Lewis and the News, “Hip to Be Square.”

A white-knuckle-grip on market pessimism continues as the Federal Reserve Board of Governors (aka the Fed) is nearing the end of, if it’s not already finished with, its cycle of interest-rate increases to tamp down inflation—a status that’s usually good for stocks.

Corporate earnings have been coming in much better than expected, and the economy keeps resiliently chugging along, propelled by historically high employment. More people working is the elixir for economic growth, which is usually accompanied by a growing stock market. But in recent months, some investors have perversely shunned good economic news because it may mean more Fed interest-rate increases, denting their stock holdings a bit. They forget that in a poor economy, it’s difficult for many stocks to thrive.

Still Spending

Consumer confidence is quite negative but, as is their wont, Americans keep spending. Of course, the well-heeled are doing so, especially now that most people feel liberated to travel and eat out, post-pandemic. But lower earners are also spending apace, running up total credit card balances to new highs. Some bears fret over the economic implications of this, but in the current robust economy, it’s easier to stay employed to pay off card balances.

With furrowed brows and steepled fingers, these bears speak with near certainty about steep market declines right around the corner, as though the Fed were at the beginning of a rate-hiking cycle — timing that has historically dunned stocks — instead of at or near the end.

Perhaps to burnish their images to attract clients, some bear advisors may think this makes them look smart. It’s one thing to want more data. Yet many habitual bears, hard-pressed to come up with a strong argument supporting an imminent market downturn, are apparently reflecting this paraphrase of a slogan from the 1970s drug culture: Just because you’re paranoid doesn’t mean a near-term market decline isn’t out to get you.

There’s also the all-important advisory concern of managing client expectations. If the market goes down, bear advisors don’t want their clients to think they were clueless. If it suddenly goes up, they want clients who miss out on key early gains to take solace in the fact that they were being protected from downside risk. Also, many persistently bearish advisors doubtless are still wincing from having kept their clients in the market too long into 2022, exposing them to losses from the then-developing bear market.

Sax and Signs

The lyrics of “Hip to Be Square,” address how social and cultural trends had changed from the laissez-faire, hedonistic ’70s to the more conservative ’80s. Paralleling this in market views today, inveterate bears think it’s cool to be skittish despite a preponderance of positive indicators. You can almost hear the song’s catchy saxophone part when considering this view in light of various positive market signs.

Among them:

• First-quarter earnings were down only about 3% year over year, as opposed to the widely expected 7%. About 80% of the S&P 500 companies beat their projections. As earnings are a fundamental driver of stock prices, this was better-than-expected news for investors.
• These earnings are all the more robust when you consider that all-time-high company revenues would be higher if they weren’t being squeezed by rising labor and commodity costs, points out Ed Yardeni of Yardeni Research. Yardeni, who believes a new overall bull market has already begun, adds that these pressures on earnings will probably soon ease as inflation continues its downward trajectory. Then, investors will get the full benefit of high corporate revenues, and this may be a tailwind for stocks in the second half of this year.
• If history is any guide, the Fed’s apparent current pause in rate hikes probably means a rising stock market. In eight of the last 10 rate-hiking cycles, the S&P 500 was up an average of 14% a year after the last hike. Though the Fed might not be finished, the end of the cycle is clearly in sight. Many economists believe that, after starting rate hikes too late, the Fed has continued to hike too long, and thus may have to dial rates back sooner than it otherwise would. This, in turn, would probably have the effect of goosing stocks, as it did when the Fed slashed its Fed funds rate to nearly 0 in 2020 (causing all rates to plummet) to address economic damage from pandemic shutdowns. 
• Stock market volatility has recently been quite low on average. At this point in the market cycle, that’s often a sign of near-term stock gains. This view is shared by short sellers, professional traders who make bets that specific companies will soon decline in price. Short sellers have a motto: Never short a dull market. Thus, they may see gains ahead.

Some Less Bearish

Some big investment houses have brightened their 2023 year-end projections. Bank of America, for example, now puts the S&P 500 at 4,300 at year’s end, up from 4,000. (On May 31, this index was hovering around 4,180.) And recently, J.P. Morgan representatives were talking about the potential for a near-term market “breakout,” a view that amounts to an about-face for a firm whose CEO, Jamie Dimon, projected extreme bearishness last winter in forecasting an economic “hurricane.” Following Dimon’s new lead, some of the bear-hip crowd have also softened their case for a market-crippling recession. This revised view is reflected in the May Bank of America fund managers’ survey, in which about 63% of respondents said they expect an economic soft landing — that is, no recession. What else can they say now that an a previously “imminent” recession is arriving with the punctuality of Godot?

Yet many bears persist in their pessimism nonetheless. They cling to their belief that a recession is on the doorstep and that this will punish the market—though recessions don’t always have this effect and most economists say a recession anytime soon would be short and shallow. Moreover, there would still be buying opportunities (there almost always are) because some stocks do well when others falter. Hence the case for active management — where advisors pick stocks — over passive management, where investors rely on indexes. And currently, passive investing (aka indexing) in capitalization-weighted growth stock funds carries risk from the increasing dominance of huge tech companies, especially Apple and Microsoft.

Many individual investors think this is a terrible time to put new money in the market, as recent surveys reflect highly negative investor sentiment. Meanwhile, bond allocations have hit their highest level since March 2009, as money has flowed from stocks to bonds in seeking levels of safety that are no longer reliable, as bonds are increasingly moving with stocks.

All this makes the present a great time to buy stocks. A dour mood, particularly among individual investors, is suppressing prices, creating opportunities for those who have cash available to get in low.

The history of individual investing is a sad litany of people damaging their wealth by buying high and selling low instead of vice versa. Current negative investor sentiment is often a buy signal for contrarians, who run counter to the herd. The herd is obligingly tamping down the prices of worthy stocks.

Dave Sheaff Gilreath, CFP, is a founding principal and CIO of Sheaff Brock Investment Advisors, an investment firm for individual investors, and Innovative Portfolios®, an institutional money management firm. Based in Indianapolis, the firms manage assets of about $1.3 billion. The companies mentioned in the article may be held by those firms, Innovative Portfolios’ ETFs, affiliates or related persons. There may be a conflict of interest in that the parties may have a vested interest in the companies and the statements made about them.