Welcome to RBC’s Markets in Motion podcast, recorded May 3rd, 2022. I’m Lori Calvasina, head of US equity strategy at RBC Capital Markets. Please listen to the end of this podcast for important disclaimers.
This week in the podcast we tackle the topic of investor sentiment, which has been back in focus given the S&P 500’s recent decline. The big things you need to know: (1) The 13.9% drawdown in place at Friday’s close is near the range of prior growth scares, but our growth scare framework points to possible downside in the S&P 500 to 3,850 even with no recession if the Friday low doesn’t hold. (2) Net bullishness on the AAII retail investor survey broke to a new post-Financial Crisis low last week, a contrarian buy signal for stocks on a 12-month forward basis. (3) Positioning among asset managers in US equity futures hasn’t been quite as extreme, which suggests that institutional investor sentiment still needs to catch down to retail investors. (4) Other widely watched fear gauges, the VIX and equity put/call ratio have moved up, another longer-term contrarian buy signal for stocks, but don’t look extreme yet. Overall, we think the data continues to paint a picture of extreme fear and a contrarian opportunity for longer-term investors, even though there is scope for further movement/more downside in the very near term on some gauges.
If you’d like to hear more, here’s another five minutes. While you’re waiting a quick reminder that if you’ve found our work helpful, we’d appreciate your vote in this year’s All America Research survey in the Portfolio Strategy category when voting opens in a few weeks. Now, the details.
Takeaway #1: The 13.9% drawdown in place at Friday’s close is near the range of prior growth scares, putting a bottom in the markets in play, but our growth scare framework also points to possible downside in the S&P 500 to 3,850 even with no recession if the Friday low doesn’t hold.
- Although the S&P 500 fell below its March 8th closing low on Friday, daily trading in the index still resembles most of the post-Financial Crisis growth scares that we’ve previously highlighted as being useful reference points for how low US equities could trade in 2022. Those prior episodes—the 2010 European debt crisis, the 2011 US debt downgrade, the 2015–16 earnings/industrial recession, and the late-2018 China trade war/QT sell-off—saw declines ranging from 14% to 20% with an average decline of 17.7%.
- As of Friday’s close, the S&P 500 was 13.9% below its January 2022 peak, putting it close to the range of a typical growth scare. If a median growth scare drawdown of 17.7% occurs, the S&P 500 would fall to ~3,950 this time around, while a late-2018-type drawdown of -19.8% would take the S&P 500 to ~3,850. We see those as the potential downside levels to watch in the near term if Friday’s low doesn’t hold, even if recession is still avoided.
- Note that if we are wrong in our assumption that a recession will be avoided, there’s much more downside risk in stocks, as recession drawdowns since the 1920s for the S&P 500 have averaged ~32% vs. their pre-recession peaks.
Takeaway #2: Net bullishness on the AAII retail investor survey broke to a new post-Financial Crisis low last week, a contrarian buy signal for stocks on a 12-month forward basis.
- As April came to an end, bulls in the weekly AAII retail investor survey stood at just over 16% while bears had risen to more than 59%. Net bullishness had fallen to -43%, the lowest level seen since March 2009 when this indicator hit -51%.
- As we’ve discussed on the podcast before, when net bullishness has been below the -10% threshold that has tended to send a strong contrarian buy signal for the US equity market since late January 2022. Below the -10% threshold on the 4 week average, 12-month forward gains have averaged 15.5% since 1987.
- We think this deep level of bearishness is one of the reasons why equities rallied back Monday and the best reason for thinking any further downside will be limited from here.
Takeaway #3: Positioning among asset managers in US equity futures hasn’t been quite as extreme, which suggests that institutional investor sentiment still needs to catch down to retail investors.
- While retail investor bearishness on equities has been extreme in early 2022, that simply hasn’t been the case for institutional investors. And it may simply be that in order for the US equity market to bottom, institutional investor sentiment needs to catch down to retail.
- We monitor institutional investor sentiment by keeping a close eye on the weekly CFTC data on asset manager positioning in US equity futures.
- This indicator attempted to put in a bottom in Nasdaq contracts in March after hitting levels that had marked important lows/turning points in the past.
- That also happened with the Russell 2000.
- But these stats never quite returned to the lows of the past for S&P 500 contracts (PAUSE) Flip to slide 10 or US equity futures as a whole, pointing to lack of capitulation among institutional investors more broadly.
- In the latest update reported on Friday, capturing data as of last Tuesday, this indicator had begun to decline again for S&P 500 contracts and US equity futures contracts as a whole but had not quite returned to its 2018–20 lows on a notional basis, which we suspect will be an important threshold to monitor in coming weeks.
Wrapping up with takeaway #4: Other widely watched fear gauges, the VIX and equity put/call ratio have moved up, another longer-term contrarian buy signal for stocks, but don’t look extreme yet.
- We’re also keeping a close eye on the VIX and equity put/call ratio, which have both become elevated recently. The good news about the recent moves higher in these so-called fear gauges is that, like AAII net bullishness, they tend to be good contrarian signals for the stock market over the longer term. Since the late 1990s, when the VIX has moved up above 25, the 12-month forward gain in the S&P 500 has been more than 17% on a median basis.
- The stats on the equity put/call ratio are less robust but tell a similar story.
- The bad news about the recent moves higher in these fear gauges is that, unlike AAII net bullishness, they don’t appear particularly extreme right now. While the VIX is starting to approach some of its post-Financial Crisis highs, the equity put/call ratio has more room to travel before hitting most of its own post-Financial Crisis highs. In this context, these two fear gauges may be more like the CFTC data on broader US equity market and S&P 500 futures positioning (which has had more distance to travel before suggesting that the bottom is in) than the AAII survey (which already suggests that sentiment may have seen its lows).
In conclusion, we think all of this data paints a picture of extreme fear and a contrarian opportunity for longer-term investors that’s unfolding, even though there is scope for further movement/more downside in the very near term on some the gauges we’re watching. We’re sticking with our year-end 2022 target of 4,860 on the S&P 500.
That’s all for now. Thanks for listening. And be sure to check out our sister podcast, RBC’s industries in motion, for thoughts on specific sectors from RBC’s team of equity analysts.