Excess Optimism is Negative for the Stock Market

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Research shows that extreme optimism coincides with market tops. The question is, where are we now in the cycle? Has the mood reached extreme optimism? Possibly if we refer to some sentiment indicators. Let’s not forget the S&P 500 is up 19% since the December low, this surely can be described as an optimistic move. Because since December the US economy is losing steam. So we have a rising stock market accompanied by a slowing economy. Until now the job numbers were supporting a growing economy, president Trump often refers to the job report to measure the health of the US economy. This is changing, the latest nonfarm payrolls increased by 20K in February, well below market expectations of 180K. It was the lowest job gain since February 2017.

Other economic number are not great either, a number of high profile US companies are closing branches / laying off workers, many retailers are bankrupt, manufacturing is in decline, home sales are in decline…The stock market is rising because Trump is promising good news and the Fed made a policy u-turn, as the stock market was crashing. Surely Trump should have known that his trade war would be bad for the global economy and the Fed should have known that rising interest rates would be bad for the stock market. This tells us that we cannot trust them, if they can’t see what’s coming who can?

 

Investors are still addicted to stimulus, they have not yet realised that stimulus  has a low impact on economic activity. This explains why the stock market crashed last year, after many years of stimulus. If the Fed starts QE again chances are the stock market will crash again. Not immediately (unless investors lose confidence in the Fed) but later. Of course market crashes will become more frequent, that is the drawback of increasing the money supply. This rally won’t go far, it is a kind of dead cat bounce that could still go higher but chances are it will end below the all-time high. It all depends on the way investors will behave, as long as they trust the Fed the rally will continue. A loss of confidence is the greatest threat, I believe investors will lose confidence in the Fed that is when the bear market will resume.

Thierry Laduguie is Trading Strategist at www.e-yield.com

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