Inflection Point of Investor Sentiment Foretells a Stock Market Crash
Investor sentiment drives the stock market. If investors are optimistic, we see a rally. If they are pessimistic, we see a stock market crash.
We could be standing at an inflection point where investor sentiment could be turning from optimistic to pessimistic. This is not good. It foretells that a crash is ahead.
The first-quarter earnings season made it clear that investors aren’t fans of stocks as much as they were in previous years.
Consider this: as of May 18, 93% of S&P 500 companies reported their earnings. The earnings growth rate in the first quarter was nothing but great: 24.5%. That’s the highest it has been since the third quarter of 2010. (Source: “Earnings Insight,” Factset, May 18, 2018.)
S&P 500 companies have also been hitting it out of the park in terms of beating earnings estimates. On average, the companies have been posting positive earnings surprises of 7.5% (meaning they beat their earnings estimates by that percentage). This is the highest average since the fourth quarter of 2010.
You see, usually when a company beats its earnings estimates, investors get excited and they rush to buy the stock.
These days, investors are far from excited.
In the four-day period (two days before and two days after a company’s earnings release), S&P 500 companies that reported positive earnings surprises saw their stock prices increase by just 0.1%. This is well below the five-year average of 1.1%.
S&P 500 companies that reported earnings below estimates saw their stock prices drop 2.7% in the four-day period. This was a bigger decline than the five-year average of -2.4%.
At its core, this trend is saying that investors aren’t very optimistic. They haven’t really been buying stocks of companies that have shown solid earnings. They have also been punishing companies that have been underperforming.
Go back a few years and they were buying anything and everything. Revenue and profits didn’t matter at all.
Mark these words: this tells us that a stock market crash could become a likely scenario.
Investors Are Ditching Stocks
This isn’t all; it looks like investors have been ditching stocks.
According to the Investment Company Institute (ICI), long-term U.S. stocks, mutual funds, and exchange-traded funds (ETFs) witnessed withdrawals of almost $52.9 billion between January and March of this year. (Source: “Long-Term Mutual Fund and Exchange-Traded Fund (ETF) Flows,” Investment Company Institute, last accessed May 22, 2018.)
Looking at the weekly data, in April another $8.3 billion were taken out of long-term U.S. stocks, mutual funds, and ETFs.
Are investors anticipating some sort of a stock market crash?
Don’t Get Complacent if You Are Looking to Buy the Dip
Dear reader, key stock indices have had a solid run to the upside over the last few years.
Thanks to easy money and low interest rates from the Federal Reserve, everyone jumped in to buy stocks.
Even companies on the key stock indices became stock pickers; they bought back their own stocks by a very large amount. In 2017, they bought back $519.4 billion worth of their own stocks. (Source: “S&P 500 Q4 2017 Buybacks Rose 6.0% to $137.0 Billion; Full-Year 2017 Fell 3.2% to $519.4 Billion,” PR Newswire, March 21, 2018.)
This amount of money is larger than the gross domestic product (GDP) of a lot of countries.
Looking at how investors have been behaving regarding the earnings surprises, and with withdrawals from mutual funds and ETFs, it’s clear that the excitement isn’t there.
Know this: once the excitement disappears, a stock market crash could follow. Don’t get too complacent if you are “buying the dip” in key stock indices.