By Rusty Vanneman, CMT, CFA, BFA
Behavioral finance is the rage among many investment professionals today, including financial advisors and professional portfolio managers. There are a bevy of excellent books, podcasts and websites on the topic. It’s for a good reason too. Arguably the leading reason for investors not attaining higher returns with their investment portfolios is due to what is often called the "Behavior Gap." This is when an investor’s return is lower than an investment’s return. This is most often due to what many would call “performance chasing” or the fancier term which is called “Recency Bias.” This is when an investor buys an investment after it has already significantly gone up in price or sells it after it has already significantly gone down in price. As the notable saying by the father of fundamental security analysis Benjamin Graham quote once famously stated, “In the short run, the market is a voting machine but in the long run it is a weighing machine.” (This is also the motivation behind the title of our weekly podcast.)
In the short-term, market returns are often driven by emotion. So, how is investor sentiment looking now? Using the latest weekly American Association of Individual Investors AAII Investor Sentiment Survey, investor sentiment is currently in the most negative quintile for net weekly bearish sentiment going back to 1987. Historically, when this is the case, the U.S. stock market has produced an above-average stock market gain in the following 1-, 3-, 6- and 12-months. Stay invested, stay diversified, and stay disciplined.
Just About Six Months On
By Tim Holland
As we know, individual stocks and the stock market overall — over the long term — are driven by fundamentals, the most important of those being, we think, earnings and interest rates. Concerning earnings, the greater the earnings growth and the more consistent the earnings growth, the more investors should be willing to pay for a specific stock or for the market overall. As it concerns interest rates, the lower interest rates are the more valuable future earnings become — for an individual company or for the market overall — and the more attractive equities are relative to their traditional competition for capital, fixed income. That said, over the short term, there are non-fundamental factors that can drive market returns and non-fundamental lenses through which to view the market. Sentiment would be an example of a factor that can drive returns near-term, where excessive bearishness is historically bullish for stocks and excessive bullishness is historically bearish for stocks, while the political calendar would be an example of a non-fundamental lens through which to view the market, which is also the subject of this week’s note.
Going back to the mid-term election of 1962 through the mid-term election of 2020, the S&P 500 has always been higher six months on from election day, posting an average gain of 15.1% (see chart). And as we sit here today, a week out from the six-month anniversary of the 2022 mid-term election, and at the risk of jinxing it, the S&P 500 is up 9.5% from its close on November 7th (election day was November 8th). For those looking to establish a relationship or a cause and effect between the political calendar and market returns, one could put it down to getting through the uncertainty of the mid-term election and the belief that the party that holds the White House will do all in its power to ensure it continues to hold the White House come the next Presidential election (which should mean pursuing market-friendly policies into the third year of the Presidential cycle). And as it concerns market fundamentals today, we do expect earnings growth to be challenged this year but interest rates to be biased lower, creating, on balance, a supportive backdrop for stock prices through 2023.