Confidence is Sentimental

You don’t need to look further than the headlines to see how fearful the world is today. But on Tuesday, we got another gauge courtesy of pollster Gallup, which announced its daily economic confidence index fell 12 points to -34—the latest in a series of pullbacks from this year’s earlier climb. Though no one metric perfectly captures investor sentiment, this poll’s recent trend helps illustrate the emotional journey investors have taken this year. Green shoots of optimism have retreated into grinding skepticism, strongly suggesting this bull market is far from over.

Investors have seemingly ridden a sentiment roller coaster recently. Once a New Year’s Day 2013 deal left the fungible Fiscal Cliff in the rearview mirror, many were worried the associated tax hikes and the dreaded “sequestration” budget cuts would push the economy back into recession. But when they came and GDP growth stayed the same-ish, sentiment seemingly started to shift from skepticism to optimism. The economy continued to show signs of improvement, and in a change of pace, investors started to notice! Folks weren’t uniformly sunny, but they were willing to acknowledge rising corporate earnings and admit the US economy was chugging along (albeit not swiftly). The investing public was seemingly divided between skeptics and optimists.

And then taper talk began. And interest rates rose a tad. And Syrian tensions rose. And the shutdown. And the debt ceiling. All of which headlines screamed would be just utterly disastrous for markets. Investors got spooked! Sentiment retreated to skepticism.

As a result, investors largely ignore the many positives which, in our view, overwhelmingly show the global economy is in fine shape—even more so once QE ends. That means investors are also ignoring the potential for continued earnings growth—potential that doesn’t seem anywhere near baked into stocks. Valuations are still below their long-term averages, suggesting sentiment has a long way to go before investors start placing a big premium on future earnings.

Consider just some of the positive developments folks have ignored amid budget and taper terror. Global growth is revving up. The eurozone recently emerged from recession—its 18-month absence from global growth is over. Japan, too, is contributing to global growth. Emerging Markets have stabilized and should speed up as yield curves widen globally. Here at home, too, reacceleration appears nigh. US banks have healthy balance sheets, and profits are rising as the yield curve slowly steepens. When QE ends, it should steepen further, boosting banks’ potential operating profits and motivating them to lend more freely—businesses will get more capital for growth-oriented spending. High and rising corporate profits provide another boost. Retail sales and consumer spending are improving. The shale oil boom is helping reduce household and business energy costs, not to mention spawning new industrial activity—a nice economic tailwind. All of these, and more, have gone underappreciated—some even unnoticed. But at some point investors will notice, and improving sentiment should lift stocks.

It won’t happen overnight—confidence typically ascends gradually. Today, dour sentiment is keeping markets from fully weighing fundamental reality. As investors gradually begin realizing reality is better than they thought, false fears of a weak world will flip to rational optimism, and they’ll gain increasing confidence in stocks’ future earnings and become willing to pay more and more for a share in them. No one can say for sure how long this will last. But with sentiment this dour, it’s tough to envision a catalyst for full-blown euphoria within the foreseeable future, suggesting this bull should run for some time.