Key Points
  • U.S. stocks have surged on hopes of a near-term “phase one” trade deal; yet major issues remain unresolved and investor sentiment is getting frothy.

  • Upside surprises in payrolls have reinforced the strength of the labor market and consumer, underlining the bifurcation within the broader U.S. economy.

  • Hints at global fiscal stimulus are starting to manifest themselves in policy plans, signaling a concerted shift away from monetary easing.

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“Extraordinary claims require extraordinary evidence.”
― Carl Sagan

Take it to the limit

U.S. stocks have broken out to the upside and surpassed their all-time highs. Recent gains have come on the heels of increased hopes of a signed “phase one” deal by year-end; the Fed’s accommodative rate cut in October; and better-than-expected results from October’s payroll data. Yet, though the past month’s rally has been confirmed by cyclical leadership and relative strength within small-cap and value stocks, caution is warranted; as earnings growth in the third quarter is still expected to be negative year-over-year (as per Refinitiv data), investor sentiment is approaching excessively optimistic levels, and a “skinny” U.S.-China trade deal is unlikely to lift corporate animal spirits. More broadly, U.S. real gross domestic product (GDP) growth estimates for the fourth quarter—as measured by the Atlanta Fed’s GDPNow forecast—have edged down to 1% as of November 5, 2019.

Investors have largely shrugged off various headwinds and embraced riskier areas of the market; yet the reversal hasn’t masked the broader (nearly) two-year defensive trend. You can see from the two charts below that while cyclical sectors have assumed leadership over the past month, they have still lagged their defensive peers over the past 22 months.

Cyclical Sectors Have Led the Recent Market Rally…

110819_Sector Performance 100119-present

Source: Charles Schwab, Bloomberg. For illustrative purposes only. Past performance is no guarantee of future results.

…Yet Defensive Sectors Still Rank Higher Over the Long-Term

110819_Sector Performance 012618-present

Source: Charles Schwab, Bloomberg. For illustrative purposes only. Past performance is no guarantee of future results.

Coinciding with the recent risk-on behavior has been a surge in optimism among various measures of investor sentiment; including one that we track daily—SentimenTrader’s “Smart Money and Dumb Money Confidence” measures. The former cohort consists of institutional and professional investors, while the latter includes smaller odd-lot traders and investors; and they are behavioral measures in that they track how the cohorts are positioned. As you can see in the chart below, “Dumb Money” confidence has surged of late; yet the rub is that, typically at extremes, the “Smart Money” correctly identifies excessive optimism and sniffs out a subsequent market pullback. Should that be the case in the near future, it wouldn’t be all too surprising; considering U.S. stocks have rallied on decreasing uncertainty in the near-term, rather than confidence in longer-term fundamentals.

“Smart Money” and “Dumb Money” Have Diverged Again

Smart Money vs Dumb Money

Source: Charles Schwab, Sentiment Trader, as of 11/7/2019. Confidence Indexes are presented on a scale of 0% to 100%. When the Smart Money Confidence Index is at 100%, it means that those most correct on market direction are 100% confident of a rising market. When it is at 0%, it means good market timers are 0% confident in a rally. The Dumb Money Confidence Index works in the opposite manner.