I have not written a post in over a year about the overall market. For nearly two years the market climbed higher despite extreme sentiment readings, with only minor blips along the way. Historically, Investors Intelligence bears readings below 20% were a warning sign. Yet for the better part of two years Investors Intelligence bears were under 20% with no repercussions. There are numerous such examples. After a while I decided to stop pissing in the wind and stopped writing posts about the extremes in sentiment. With all the nervousness out there (myself included) I thought this would be a good time to update my market thoughts.
I believe the reason sentiment stopped working was that corporations have been providing a steady bid in the market through share repurchases and cash M&A. In the past couple of years corporations finally started to use the nearly free money in the bond market to lever up in earnest. I believe this steady bid from corporations combined with a positive feedback loop from investors has led to this steady grind higher. I would note that the S&P 500 has outperformed both small caps and international equities, as the bulk of share repurchase and cash M&A occurred in larger cap US stocks.
The good news is that the backdrop of corporations using cheap money to purchase stock is still in full force. Corporations are still able to borrow cheaply and are doing so. In a recent three week period about $60 billion of cash M&A was announced, while the steady repurchases largely continue. The economic backdrop of steady yet uninspiring growth continues as well.
The bad news is that investors have grown complacent after two years of relatively little pain. Individual investors have historically high allocations to stocks, margin debt is at a record and I have heard endless stories of institutional allocators in search of more beta. It appears that this positive sentiment is being unwound and given the aggressive positioning of the investment community there could be more to come.
If the unwind of excessive sentiment continues it is likely to trump corporate buying in the near term and the sharp, painful correction is likely to continue. However, over the medium term the steady bid from corporations is likely to assert itself again. Corporate buying combined with positive seasonality starting in November, make it likely that near term losses would be recuperated over the next few months. But in the interim it could get ugly and a few more sleepless nights may be ahead for investors.