Scared & Loaded

I continue listening and considering all bearish arguments for stocks, but for now, I can’t ignore the Big Beautiful Elephant in the room!

Appropriately, investors are generally immersed in the daily minutia surrounding the financial markets. How are valuations looking? Are earnings estimates rising or falling? Is inflation or a recession a threat? What will the Federal Reserve do with interest rates? The money supply? Will bond yields behave? Any external challenges to monitor – political riffs, global tensions, regulatory changes, bankruptcies … ? What is currently hot or not? Any good momentum plays or contrarian ideas to consider? Domestic, international, technology, financials or health care? What about market technicals? Is the S&P still trending above its 200-day moving average? Is that a rounded top, a double bottom, or a major reversal? “Lions and Tigers and Bears, Oh My!”

Nothing wrong with investors doing their homework. But sometimes when diligently juggling all the important facets to consider, investors can develop a tunnel vision and simply miss the elephant in the room. I think there are numerous factors investors need to be assessing today and several of the issues mentioned above are on that list. Nonetheless, I spot an elephant in the room and it probably “Trumps” (pun intended) everything else!

Investors are Scared & Loaded

Currently, investors are scared & loaded – a character generally only evident at major stock market bottoms.

Chart 1 shows the U.S. consumer confidence index since 1952. Confidence currently is near one of its lowest levels in post-war history suggesting pessimism and fear of the future is more pronounced today than at almost any other time during the last 75 years! Despite not having an official recession since March 2020 and only one other recession since 2009-10, and despite being in a bull market now for nearly four years, pessimism among potential investors – main street consumers – is remarkably pronounced.

Chart 2 demonstrates that in addition to households being pessimistic and fearful, they are also “loaded” with dry powder or rainy-day funds! Since 1950, U.S. household liquid assets as a percent of disposable personal income has ranged between 45% to 85% and is currently near 70%. Dry powder sitting on the sidelines is immense at $15.44 trillion – near a post-war high – and is more than double what it was at the bottom of the 2008-09 bear market and above where it was at the worst of the 2020 pandemic.

Many frequently compare the contemporary bull market to the dotcom boom during the 1990s. Similarly, the current bull has been highly concentrated among tech darlings, and it has lifted tech valuations and the overall S&P 500 valuation to very high levels. However, charts 1 and 2 show that the current bull market appears much less vulnerable to a collapse today compared to the dotcom top in 2000. In 2000, confidence on main street was at a post-war record high near 115. Today, the main street confidence index at about 60 is near a post-war low. Moreover, at the top of the dotcom mania, household dry power as a percent of disposable personal income was at a post-war low of only about 45% whereas today it is near 70%. Even though the contemporary bull has been tech driven and highly concentrated, its current position is nearly the contra opposite of the top of the dotcom market. In 2000, households and investors were fully invested with cultural emotions verging on irrational exuberance. Today, households are sitting on considerable potential buying power and arguably are irrationally pessimistic.

Introducing the Cash/Confidence Ratio

Chart 3 illustrates the cash/confidence ratio which is essentially chart 2 (cash holdings) divided by chart 1 (confidence). Currently, this ratio at 0.0113 is at the fourth highest peak level and is higher than 97.2% of the time since 1952. Investors are scared and loaded, and this should be very encouraging for stock investors!

Many currently suggest stock investors should be cautious. Valuation is high, aggregate investment exposure is pronounced, there are concerns about pending inflation due to tariffs, the Federal Reserve suggests it can be patient in holding interest rates and yields at relatively high levels, economic growth has slowed and may slow even further, and a recession and an earnings collapse are still possible. Moreover, the S&P 500 has already risen by almost 75% during this bull market and has surged by almost 25% just since April 8^th. Several analysts and strategists make a compelling case that stock investors should proceed with caution.

However, there is an elephant in the room and it’s a big one! Chart 3 demonstrates that investors can currently buy the U.S. stock market with a backdrop or character which is very similar to what existed at the bear market lows of 1974, 1980, 1982, 1991, 2009, 2020 and 2022. Certainly not all characteristics today are consistent with past bear market lows, but two important criterion which drive the initial stages of most bull markets – pessimism and excessive dry buying powder – are evident.

Although I worry about many of the same issues bearish strategists highlight today, my guess is the big elephant in the room – the ability to buy stocks when attitudes are extremely pessimistic and when substantial idle buying power is sitting on the sidelines – is too compelling to ignore. Current risks associated with valuation, inflation, recession, Fed tightening, Trump tariffs, and geo-political conflicts notwithstanding, as chart 3 demonstrates, the opportunity to buy stocks when everyone is scared about the future and have stockpiled cash cannot be ignored.

The Performance Power of the Cash/Confidence Ratio

Chart 4 illustrates how historically powerful a high cash/confidence ratio has been since 1952. It records the average annualized quarterly S&P 500 total return performance since 1952 for all quarters when the cash/confidence ratio declined compared to how the S&P 500 performed when this ratio rose. For all quarters since 1952 when the cash/confidence ratio declined the S&P 500 average annualized total return was a stunning 26.4% compared to an average annualized S&P 500 total return of -0.31% for all quarters when the cash/confidence ratio rose.

Moreover, during quarters when the ratio declined, the annualized standard deviation of S&P 500 quarterly total returns was only 12.6% compared to 16.9% when the ratio rose. Perhaps most astounding, for all quarters since 1952 when the cash/confidence ratio declined, the S&P 500 suffered negative quarterly total returns only 13.7% of the time, whereas for all quarters when this ratio rose, the S&P 500 suffered a negative quarterly total return 45.9% of the time.

The cash/confidence ratio is currently higher than 97.2% of the time since 1952. Isn’t the cash/confidence ratio much more likely to fall rather than ruse in the coming year?

Final Comments

The contemporary U.S. bull market did not just begin; it’s nearing the end of its 3d year. Nonetheless, the current bull exhibits two strong characteristics which perhaps effectively makes it much younger than its calendar age. Throughout the current bull market, pessimism has been chronically elevated and idled buying power has remained abnormally large.

Since the contemporary bull will soon enter its fourth year and has already risen significantly since October 2022, maybe today’s very high cash/confidence ratio will not prove as dramatically positive for total returns as it has in the past. However, having a contemporary cash/confidence ratio which is among the 97% highest since 1952 should not only improve the likelihood of better-than-expected returns but also probably limits downside stock market risk. A high cash/confidence ratio in the stock market is similar to a low debt/equity ratio in the economy. The former enhances potential upside while limiting stock market selloffs and the latter promotes ongoing economic growth with lower recession risk.

I continue listening and considering all bearish arguments for stocks, but for now, I can’t ignore the Big Beautiful Elephant in the room!

Thanks for Taking a Peek! Jimp

Disclosures________________________________________________________________

Please note that stocks are inherently risky. Any stock can lose most of its value at any moment, including any stock I mention here. You should never rely on a single source for investment decisions, including me. I am a retired investment strategist offering opinions and observations on the markets, the economy and companies. You should do your own research and also consult a qualified financial planner and investment advisor before making investment decisions.

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