We talk a lot about stock market fundamentals in our research and for good reason.
Stocks tend to follow trends in the economy and earnings over long periods of time. But the market’s day-to-day moves can depend on several different factors, including investor emotions. Those “feelings” tend to ebb and flow with how the market’s doing and what headlines pop up each day.
It’s often difficult to judge which feelings are driving the market, especially these days. Investors are grappling with healthy doses of euphoria and fear right now, even though hope could ultimately carry stocks higher.
Market emotions ultimately shouldn’t distract you from your goals. But understanding the risks and opportunities tied to these emotions could help you prepare for what comes next.
Pull up a chair, and let’s talk about feelings.
Market excitement can be a good thing. Lately, the stock market has gone mainstream, leading to more people learning about the benefits of investing and building wealth. The internet and social media have made it easier than ever to research the securities you’re buying and selling. Additionally, technological improvements and reductions in trading fees (such as commissions) have made the market more accessible. We’re fans of the democratization of investing over the past decade.
However, market excitement can turn into euphoria, and that’s when caution may be warranted. Euphoria happens when risk is elevated but ignored. In that scenario, a slight bit of bad news could send everyone running for the hills at the same time. Robert Shiller, a famous economist, once wrote that public excitement about markets and envy over investors making money are two prominent signs of a stock market bubble. Sound familiar?
High valuations, a hot IPO market and increased speculation can also be signs of euphoria. Despite the similarities to the current environment, there are a few reasons why we don’t think excitement has turned into euphoria yet. We believe the commitment from the Fed to keep rates low, the market’s rotation, and the potential for rising earnings estimates will offset some of the risk in the market.
Investors can always find something to be worried about. It’s part of what makes a market work.
These days, stocks are swinging around near record highs, including a few intraday moves greater than 2% last week. That can be an indication the market lacks direction. Some are concerned that progress is stalling in some areas of the economy, like the job market. On top of that, the pandemic is still evolving, and we are less than a year removed from a vicious bear market.
Other signs of anxiety include an elevated VIX (Chicago Board Options Exchange Volatility Index, the fear gauge of the stock market), bond prices and gold prices. These signs are evidence that uncertainty has not subsided.
This skepticism could be healthy though. While fear may entice people to sell, anxious investors tend to pay more attention to risks. They also hedge their portfolios, which makes them less likely to sell when the market falls. Fear can also lead to more cash on the sidelines that may flow back into the market if there’s a pullback. That’s why stocks have historically done better when the VIX has been above its long-term average of 20.
Seasoned investors will tell you that the worst selloffs happen when the market least expects it. That doesn’t seem to be the case right now.
Perhaps the most important emotion that’s driving the markets right now is hope, even though there’s a fair share of fearful and euphoric investors. Parts of the economic and earnings rebound have blown expectations out of the water, and we’re staring down the end of the pandemic as vaccines get into arms.
The hope is heavily rooted in fundamental reasoning too. U.S. companies are posting another stellar earnings season, a big market win that’s gotten lost in the GameStop noise. About 78% of S&P 500 companies’ fourth-quarter earnings have beaten Wall Street estimates — a historically high rate. Yet the index’s stocks have dropped an average of 0.5% the day they’ve reported results. Consumer savings are up, providing a good setup for an economic boom once we can travel and mingle safely.
Hope can be a powerful tailwind for stocks too. That’s why the S&P 500 has increased an average of 17% in the year after every recession since 1950. In recent months, the biggest sign of hope has been how quickly buyers have swarmed into the market after drops. This week, the S&P 500 increased more than 1% on two straight days to close within 1% of a record high — the fourth time that’s happened since 2000.
All the Feels
This market is trading more on feelings than fundamentals, and that’s led to some crazy market moves. We think hope could prevail in the end as we get closer to a post-pandemic society, but fear or euphoria could easily get in the way.
Hope doesn’t protect stocks from quick selloffs either. Sometimes the market just needs to take a step back, even when the fundamentals haven’t changed.
Don’t get too hung up on your (or the market’s) mood. Emotional decisions are never a good idea, especially when you’re building a portfolio. Besides, if you’re a long-term investor, your success could depend more on time in the market instead of emotional trading.
Lindsey Bell is Ally’s Chief Investment Strategist, responsible for shaping the company’s point of view on investing and the global markets. She is also President of Ally Invest Advisors, responsible for its robo-advisory offerings. Lindsey has a broad background in finance, with experience on the buy-side and sell-side, in research and in investment banking and has held roles at JPMorgan, Deutsche Bank, Jefferies, and CFRA Research.
Lindsey holds a passion for teaching individuals how to become successful long-term investors. She is a contributor at CNBC, and frequently shares her insights with various publications including the Wall Street Journal, Barron’s, MarketWatch, BusinessInsider, etc. She also serves on the board of Better Investing, a non-profit organization focused on investment education.
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The opinions expressed here are not meant to be used as investing advice. For more information, visit our website.