Watching For Sentiment Extremes
By Cory McPherson | November 2024
As we roll into the last month of 2024, the stock market will look to close out a great year on a strong note. Now that we’re past the election from a few weeks ago, there’s been a sense of euphoria in parts of the market. Small Caps exploded higher to finally reach their highs from 2021. Bitcoin has nearly reached $100,000. Volatility readings have waned and returned to more normal levels. One thing I’ll be watching next year are sentiment readings and looking for levels in sentiment that have historically occurred near market peaks if this euphoria continues.
One measure of sentiment would be looking at margin debt. This measures the amount of money being borrowed in brokerage accounts to trade with. This allows an investor to magnify gains if a stock continues to rise. It can also, of course, exacerbate losses if a stock were to fall and an investor was to face a margin call and required to come up with additional cash. FINRA (Financial Industry Regulatory Authority) releases data on margin debt monthly. While it has been increasing steadily since early 2023, it is still well off its peak in late 2021 as you can see with the purple line in the chart below.
Historically, margin debt has peaked near or just prior to the S&P 500. That occurred in late 2021 when margin debt peaked in October of that year. If sentiment begins to get extreme and we have a return of “animal spirits” as market commentators like to say, you would expect margin debt to surge higher and possibly get above 2021 levels. If that’s the case, stocks could continue to stretch higher. November’s numbers will be interesting to see if investors started adding on margin after the election.
U.S. consumer confidence bounced back in October just prior to the election with data being released earlier this month from The Conference Board. One data point from their survey is expectations for the stock market. Consumers have become much more upbeat about the stock market, with 51.4% expecting higher stock prices in 12 months. That is actually the highest reading since the question was first asked in 1987. Only 23.6% expect stock prices to decline.
CNN’s Fear & Greed Index is another widely followed sentiment indicator on the stock market. While it’s in greed territory currently, it has seen much higher levels previously and typically reaches extreme greed before stocks peak. This also points to the possibility of higher to go.
With higher sentiment readings in the stock market, corporate insider selling has also gone up. Corporate executive stock sales have actually reached an all-time high in the ratio of sellers to buyers as shown in the chart below.
This doesn’t necessarily mean the stock market is about to peak imminently. Insiders can have all kinds of different reasons to sell, but with markets near all-time highs and looking frothy, they’ve decided now is a good time to start cashing in. The previous high in this insider selling ratio was in 2021 a few months before the market peaked.
A recent report from Bank of America in October highlighted that mutual fund cash levels are currently at their lowest point on record at 0.6% of assets under management. This was a decline from 1.6% the previous month, a significant change considering the average monthly change is around 0.20%. This is another indication of high bullish sentiment as fund managers are essentially “all-in” with a positive outlook for growth. This may seem positive, but with low cash levels in their funds, they will be limited in their ability to buy during any market downturn. It can also add fuel to any downturn if many decide it’s time to raise cash. For the most part, mutual fund cash levels have been declining for the last 15 years outside of a rise in 2022. Like interest rates from a few years ago, as something approaches zero, it will inevitably have only one way to go.
Overall, if an important high in the market is approaching in the near future, extremes to the upside in sentiment will most likely coincide. Some have reached extremes, while others have room to go higher. All of this coincides with a continued tense geopolitical backdrop, and an uncertain near-term economic picture as a new administration comes in. As always, we’ll follow the charts and watch our support levels to guide decision-making.
I want to wish you and your family a safe and happy Thanksgiving! As a reminder, our offices are closed on November 28th and 29th and will be back open on December 2nd.
Cory McPherson is a financial planner and advisor, and President and CEO for ProActive Capital Management, Inc. He is a graduate of Kansas State University with a Bachelor of Science in Business Finance. Cory received his Retirement Income Certified Professional (RICP®) designation from The American College of Financial Services in 2017.
Disclosure