- Various measures of market and economic sentiment have turned sharply negative in recent weeks.
- Typically these are signs of a market or economy under stress.
- Neither of those conditions are in place right now, and in normal times this would be a puzzling development.
- We are not in normal times, however, and continued policy uncertainty surrounding trade is leading to apprehension on both sides of the border.
- The past month has shown us that political volatility will likely be a feature of markets for the foreseeable future, with the potential to cut both ways.
- We claim no special knowledge as to what will come next with tariffs, but market facts on the ground suggest economic growth remains sound and we see little value in making portfolio shifts based off a guess as to what will come next.
In this profession, there is a lot we need to pay attention to. Some of the move obvious subjects are what is going on with the economy, business conditions, interest rates and keeping tabs on the companies we have invested in and those that we have our eye on. On top of that we are monitoring for risks whether they emanate from an overheated economy or stock market, politics, and geopolitical events around the world.
CNN’s “Fear and Greed” Indicator suggest extreme fear on the part of investors
Ignore sentiment to our detriment
One of the less obvious indicators we have our eye on is investor sentiment. This is essentially a measurement of how other investors and the general public feel about the markets and the economy. As you might suspect, this typically has a strong correlation with the value of the stock market – when the market is riding high, most investors are confident that the good times will continue. When it is down in the dumps, so are they. Extreme readings in sentiment, particularly negative sentiment, can be important timing tools for portfolio managers, so it is something we monitor quite closely.
Below is our favourite sentiment indicator which measures the ratio of bullish to bearish investors. When the ratio is at 1.0, the number of bulls and bears is equal. Above 1, the bulls have the upper hand. Below 1, and there are more bears than bulls. When this dips below 0.5, or when there are two bearish investors for every bull, it has historically been a good time to add to stocks. As mentioned above, this typically happens after a correction has taken place in the stock market, but today’s situation is a bit different.
Stocks have been resilient to geopolitical noise
As of this writing, global stocks are about 3.5% off their all time highs and trading at levels last seen a handful of weeks ago – not typically the type of market action that strikes fear into the heart of investors. We all know, however, that we are not in typical times. Political risk is the highest we have seen it in some time, and not unexpectedly it is starting to weigh on consumers and investors. Markets have been a bit more sanguine and to our eye are betting that we don’t see tariffs to the degree that has been threatened. Put another way, the markets seem to be calling the President’s bluff.
Consumers not so confident…
Every month, an outfit called The Conference Board surveys U.S. consumers on a whole host of economic issues. This is distilled into a widely watched measure called the Consumer Confidence index. Below we focus on two forward-looking subcomponents, the expectations index, which is based on consumers’ short-term outlook for income, business, and labor market conditions, and inflation expectations over the next 12 months. What is clear to us looking at this data is that all the talk of tariffs and chaos unfolding within the U.S. federal government has spooked consumers. The expectations index peaked after the election and has fallen sharply since while 12-month inflation expectations are the highest since mid-2023 at 6%.
… despite a rosy U.S. growth outlook
This all comes in an environment where economists continue to mark up U.S. GDP growth expectations for 2025, with 2.3% growth now expected, a sharp contrast to the 1.6% they are penning in for Canada. Given the Canadian forecast dropped sharply right around the time tariff talk reached its zenith, we think it is fair to assume that the U.S. growth numbers are also taking them into account to some degree. This highlights the differing impacts on the two economies, though many industries in the U.S. would be heavily impacted should the full brunt of proposed tariffs come to pass.
What would it take to cheer up investors?
At risk of stating the obvious, clarity on tariffs would be a good start to reducing uncertainty. Even the U.S. businesses that tariffs are purportedly set to help (not to mention the fact that it will hurt many) are likely tearing their hair out and would just like some clarity so they can get on with their lives. From what we are hearing from business contacts most are sitting on their hands until they know what they are facing and we don’t blame them. In Canada this trepidation is multiplied many times over and while we should know more next week, we wouldn’t be surprised to see the proverbial tariff can kicked down the road again.
In a typical environment the combination of a growing economy, moderate inflation and declining interest rates would be enough to put investors in a good mood. Today it isn’t the current economic conditions that have people worried but what might or might not come next. At this point it is all speculation as to what one man may or may not do. The facts on the ground remain that the U.S. economy continues to grow at a healthy pace. When the economy is growing, the S&P 500 has historically been up more than 80% of the time and as we mentioned when tariff news first surfaced, much of the TSX is less exposed to tariff risk than the Canadian economy at large. To make a material change to portfolios would suggest we have information that the market does not have about the trajectory of earnings and the economy, which we can assure you we do not possess!
While they are never fun to live through, corrections happen almost every year and this year is likely to be no different. Financial plans are prepared with the knowledge that markets will have occasional setbacks and recent years of healthy returns have added a margin of safety. Unless one’s goals and objectives have changed or the facts on the ground regarding the trajectory of the economy changes, our recommendation is for investors to stay the course. We construct portfolios to succeed in a wide range of economic environments and should volatility erupt we will look to take advantage of opportunities that inevitably arise.
The Harbour Group
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