by Jeffrey Buchbinder, CFA, Chief Equity Strategist, and Research Team, LPL Financial
With additional content provided by Brian Booe, Associate Analyst, Research.
As a result of the record-breaking bull market, Federal Reserve (Fed) rate cuts, and not to mention political clarity following the U.S. election, more optimism has permeated throughout U.S. financial markets lately. While this is common, the nearly continuous rise in consumer sentiment towards the stock market has raised eyebrows.
Each month, the Conference Board issues a consumer confidence survey, a sample from approximately 3,000 households across the United States. The survey asks respondents about their optimism (or pessimism) on topics including, but not limited to, the labor market, inflation, business conditions, and the stock market. In the most recent release from the end of November, the percent of consumers who expect the stock market to increase continued its upward trend to another record high. Following a record high in October, 56.4% of respondents were optimistic about the stock market over the next 12 months, an increase of 4.5% from the previous report.
One Survey of Investor Bullishness Reaches All-Time High
Source: LPL Research, Conference Board, Bloomberg, 12/03/24
Disclosures: Past performance is no guarantee of future results.
Lopsided Sentiment
Record highs for major indexes have naturally been welcomed by investors, so broadly positive investor sentiment is not particularly surprising. However, consumers have become more bullish than ever in the history of this Conference Board survey. November survey results indicated that only 21.3% of consumers expect stock prices to decline over the next twelve months. Although this is not an all-time low, the spread between bullish and bearish consumers is at an all-time high. The spread, or the difference between the percent of consumers expecting stocks to increase and those expecting stocks to fall, hit 35.1% last month. This topped the previous all-time high from October, which beat the longstanding record of 28.6% from March 1998. For perspective, the long-term average for this spread is 7.8%, while the long-term average for those expecting prices to increase is just shy of 36%.
The Put/Call Ratio Also Leans Bullish
From a different lens, we can consider put/call ratios for clues on market sentiment. A put/call ratio is the number of puts (the right to sell) divided by the number of calls (the right to buy) for an investment, or in this case, an index. It is often used to gauge how investors feel about the market, based on demand for hedges against stock market declines (puts). The Chicago Board Options Exchange (CBOE) U.S. Put/Call Ratio Composite Index currently sits at 0.8, below the long-term average of 0.89 and the five-year average of 0.92. A lower put/call ratio indicates more calls are being bought versus puts, indicating low levels of concern about a potential stock market decline. From a contrarian perspective, more fear would be considered a bullish indicator, and vice versa. While this gauge of sentiment may not be at all-time lows, the last time the index was at the current level was during the post-pandemic rally in 2021 — when the S&P 500 returned 28.7% for the year including dividends, following the Covid-19 sell-off.
Low put-call ratios typically accompany rallies, because it is the bullishness and lack of fear that drives the buying. However, when measures of bullishness or complacency get too stretched, they can be precursors to market selloffs. As sentiment gets more stretched, we get more wary of a short-term sell-off.
Put-Call Ratio Reveals Little Fear of a Market Decline
Source: LPL Research, Conference Board, Bloomberg, 12/03/24
Disclosures: All indexes are unmanaged and cannot be invested in directly. Past performance is no guarantee of future results. The ratio of put options to call options reflects market demand for hedges against stock market declines relative to market demand for options to express a positive view of the stock market. A higher ratio reflects more concern about potential market declines.
Any options presented are as a market indicator, not as a product recommendation.
Conclusion
Following the S&P 500’s best month of the year in November, the benchmark equity index has continued to set new record highs. Already elevated consumer optimism towards the stock market has moved even higher since the start of the Fed’s easing cycle and the U.S. election, partly on hopes of lower taxes, deregulation, and strong corporate profits. However, this support for stocks is offset by stretched valuations, excessively bullish sentiment, and the potential for the economy to cool in 2025.
The LPL Research Strategic and Tactical Asset Allocation Committee (STAAC) remains neutral towards equities. The Committee prefers U.S. stocks over developed international and emerging markets (EM) on a regional basis. The domestic preference stems from superior earnings and economic growth in the U.S., which is reinforced by the policy stances of the incoming administration. Additionally, a stronger U.S. dollar increases the attractiveness of U.S. equities over developed international markets, while trade policy and tariffs remain concerns for EM equities.
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