Optimism Or Irrational Exuberance? Why Investors Are Bullish

(MENAFN- ValueWalk) Two surveys gauging investor sentiment have been released within the last seven days, and both revealed a bullish outlook for the stock market. Of course, it makes sense that the bulls would be out in force after an 18-month stretch that saw all of the major market indexes reach all-time highs.

Last year, the S&P 500 gained 24%, and this year it has already returned 15%, and we're not quite halfway through yet.

However, it's worth considering whether all that optimism is just irrational exuberance based on past performance rather than the realities of the present. Let's take a closer look.

One of the surveys came from the American Association of Individual Investors (AAII). The AAII reported that bullish sentiment, or expectations that stock prices will rise in the next six months, jumped 5.6 percentage points since early June, reaching 44.6%.

Bullish sentiment as tracked by AAII is well above the historical average of 37.5%.

Meanwhile, bearish sentiment, or the belief that stock prices will fall over the next six months, fell 6.3 percentage points to 25.7%. Bearish sentiment is well below its historical average of 31%.

Neutral sentiment stayed roughly the same, up 0.7% to 29.7% but below the 31.5% historical average.

The spread between bullish and bearish sentiment rose 11.9 percentage points to 18.9%, which is significantly higher than the historical average of 6.5%.

According to the survey published on June 13, 39.8% of investors said their six-month outlook was most influenced by the economy and inflation. That's interesting given that inflation is still high and economic growth has slowed.

The second-biggest factor for investor outlooks was monetary policy/ interest rates at 20.8%. This is also surprising since the Fed recently indicated there would only be one rate cut this year. It also supports the argument that the markets believe the Fed is being too conservative in its estimates.

The third reason cited by investors is also interesting. Although corporate earnings results have carried the markets this year, just 17.8% of investors cited earnings as a factor for their sentiment.

The fourth reason could be the most telling of all, as just 15.5% said valuations were the main factor in their outlook. This was likely the main response from those who are bearish.

Another recent survey also focused on investor sentiment, but it gauged professional fund managers rather than individual investors. However, the results were largely the same.

Bank of America Securities' Global Fund Manager Survey showed that investors are the most bullish they have been since November 2021.

“Our broadest measure of FMS sentiment, based on cash levels, equity allocation, and economic growth expectations, inched higher to 6.03 from 5.99 last month,” Bank of America Strategist Michael Hartnett said, according to CNBC .

That should raise a red flag for some people, as November 2021 was right around the time the market crashed after the previous tech bubble burst.

The survey also shows that fund managers are much less concerned about inflation than they were before, as 32% cited it as the top market risk, compared to 41% in May. Twenty-two percent of managers indicated that geopolitics was the top risk, up from 18% in May, followed by the presidential election at 16%, up from 9%.

Similar to the AAII study, there is a sense that the Fed is being too conservative regarding rates, as 80% of fund managers expect two or more rate cuts in the coming year, starting in September.

Fund managers also see little chance of a recession, with just 5% expecting a recession - the lowest total in recent months. Further, 64% now anticipate a soft landing.

After reviewing both surveys, some investors may be wondering whether they reveal wishful thinking, irrational exuberance or clear-eyed optimism.

On the one hand, corporate earnings have been strong and should improve once the Federal Reserve starts lowering interest rates. In fact, it looks like the Fed will start cutting rates soon, possibly even in September, as economic indicators like inflation rates seem to be headed in the right direction.

The big concern is valuations. The last time sentiment was this high in November 2021, the markets crashed soon thereafter as valuations had become unsustainable.

Currently, the P/E ratio of the S&P 500 is around 24, which is slightly above recent historical averages but significantly below where it was when it hit a recent high of 39 in November 2020. The forward P/E drops down to 22.

However, the 10-year inflation-adjusted Shiller P/E ratio , which is a broader snapshot, is at almost 36 - up from around 29 in September. When the market crashed in the fall of 2021, the Shiller P/E was at 38, so this is as high as it has been since the end of 2021.

The Nasdaq 100's P/E ratio is currently 31.7, which is roughly where it was a year ago. However, it is well below where it was at the end of 2021, when the P/E stood at 38 . The Nasdaq 100's forward P/E drops to 28.

The key takeaway from these surveys is that we are not quite where we were when things burst in 2021, although there are some warnings signs.

However, this is a different market than that was as the rally is broader than the technology sector. Yet, the current market is driven by mega-cap stocks, which have the earnings and cash flow to back it up. In 2020-21, we saw more stocks that were soaring even though their underlying companies had no earnings.

I can't predict what will happen; I can only present the data. However, it would be a good idea to check the P/E ratios of the individual stocks you are investing in to make sure they aren't spiking too high, particularly those of companies without the earnings to back it up.

MENAFN20062024005205011743ID1108355784