With the S&P 500 at all-time highs, market sentiment clearly is in the bullish camp; this must mean that all of our problems are solved and the future is bright for everyone.. Hold on a minute: if this were true, why would consumer confidence regarding the future decrease?
The Conference Board just released its Consumer Confidence Index, which reports favorable current conditions by respondents. I think we can all agree that the current economy is better than the conditions we’ve experienced over the past few years.
However, what is interesting is that consumers’ future expectations weakened during the month of July. Those surveyed lowered their expectations for business conditions over the next six months, as 19.1% are looking for a favorable outlook versus 21.4% the previous month. And the job picture appeared even worse as the number of those surveyed who are expecting to see more jobs over the next six months declined to 16.5% in July versus 19.7% the previous month. (Source: The Conference Board, July 30, 2013, accessed July 31, 2013.)
How does this relate to market sentiment and the S&P 500?
While consumer confidence is above year-ago levels, indicating that the current conditions are stronger, consumers are questioning the strength of the economy in the second half of 2013.
If the S&P 500 is a forward-discounting mechanism, there is the possibility that market sentiment has gotten far ahead of economic reality. I believe that a certain portion of the increase in the S&P 500 has been pushed by market sentiment that is focusing on Federal Reserve policy and not the underlying fundamentals.
The chart for the S&P 500 Large Cap Index is featured below:
Chart courtesy of www.StockCharts.com
Can the S&P 500 continue rising? Absolutely; as I said many times, market sentiment will shift when a new catalyst emerges. I believe that this could very well be the shift in monetary policy coming later this year.
If consumers are worried about the future, this will have an impact on the S&P 500. Because the U.S. economy is so dependent on consumer spending, any marginal pullback by the public would certainly hurt both earnings and revenues.
While market sentiment is firmly in the bullish camp, I believe that once the Federal Reserve begins shifting its monetary policy stance, we could see a significant adjustment to the valuation of the companies within the S&P 500.
Both market sentiment and the S&P 500 have priced in most of the good news. At this point, any shock to the system would quickly send both market sentiment and the S&P 500 down significantly. While some investors might hope for the best, I prefer to prepare for the worst. One must be ready to take advantage of significant sell-offs and jump on these opportunities. At this point, the risk-to-reward has become asymmetrical, with growing risks and reduced upside potential.
~ by Sasha Cekerevac, BA
This article was originally published at Investment Contrarians