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The Great Divergence?
by David Stanowski
05 January 2011


Abstract:
The economy and the markets turn on public mood. There are several measures of sentiment that provide very useful information about the future; consumer confidence indexes, presidential approval indexes, and sentiment indexes for each investment market.

What is the mood of the country as we head into the New Year?

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Consumer Confidence:
Consumer confidence indexes attempt to measure consumer attitudes toward the economy, employment, spending, job security, if the country is on the right track, as well as many other similar metrics.

The Conference Board's Consumer Confidence Index is one of the oldest and most respected in the business. Note how (see graph below)  consumer confidence peaked in July 2007, three months before the S&P 500 did in October. Then, it bottomed in February 2009 one month before the S&P. More recently, consumer confidence made a peak in May 2010 even as the S&P 500 pushed to a new high in December 2010; setting up a minor divergence.

Also notice how peak confidence in 2000 far exceeded the peak in 2007; showing the beginning of a long-term decline.

Consumer Confidence 1997-2010

The government has been telling us that we are in a recovery from the Great Recession that began in late 2007. What does the year end consumer confidence reading of 52.5 say about the public's outlook for 2011? In the past, a healthy organically-driven economy was associated with minimum levels of 90 on this barometer, a level we have not seen since July 2007. A reading this low says that people don't think that the Recession has ended; it just stopped getting worse about two years ago.

Rasmussen also conducted a number of year-end consumer polls. They found that people are less optimistic about the upcoming year than they’ve been in the previous seven years! Optimism about the next year has hovered in a low range in late-December surveys for the past three years. Just 35% of those surveyed expect 2011 to be a good year.

In late 2006, 57% 
expected 2007 to be a good year.
In late 2007, 68% expected 
2008 to be a good year.
In late 2008, 38% expected 2009 to be a good year.
In late 2009, 37% expected 2010 to be a good year.
In late 2010, 35% expected 2011 to be a good year.

This trend is very troubling and confirms the Conference Board results that the public is very pessimistic about the coming year.

In addition,
Rasmussen found that 46% of those surveyed believe the U.S. economy will still be in a recession at the end of 2011. Only 19% say the economy will not be in a recession by the end of 2011.

In late October, 74% said it’s likely there will be another terrorist attack in the United States in the next year, including 35% who see this as very likely.



Presidential Approval Index:
The country's attitude toward the President is another key indicator of the national mood. It represents how people feel about the "state of the union", and they express that as their feelings about the President, whether or not he deserves the blame or the credit for how things are going.

The 2008 election was unprecedented in many ways. Obama had the total and unwavering support of the mainstream media, as well as the usual liberal institutions, so he was able to run on the theme of "Hope and Change" without any specifics. Since many of his followers treated him as some kind of Messiah, it was expected that his PAI would remain very high unless and until conditions got very bad.

The following graph of the Rasmussen Presidential Approval Index shows that the day after the election the PAI only reached +8. From there, "Hope" pushed it up dramatically to +30, on 22 January 2009. However, even during one of the most dramatic Bear Market rallies in history, the PAI collapsed from this high water mark, turning negative on 30 June 2009, and it has not had a positive reading since. The PAI has been locked in a range between -10 and -20 since late 2009. The low was made on 09 September 2009 at -24; the key level to watch from now on. If the PAI breaks below -24; national troubles will be accelerating.

BHO Popularity

It should be noted that this collapse on the PAI of 54 points (+30 to -24) has taken place even as the mainstream media continue their support for this President, and most criticism on alternative outlets is still very muted in fear being labeled as racist. Many pollsters say that the current collapse in the PAI is the most dramatic in history! Can you imagine what may happen to the national mood, as expressed by the PAI, if and when things turn really bad, and the self-censorship of Presidential criticism ends?

The PAI has rallied from its September low of -24 to a year-end value of -12, but moving into the new year at this level confirms that people are not happy with the direction of the country, and expect a difficult new year.

Keep in mind that as the stock market rallied into its October 2007 all-time highs, the people's assessment of where the country was headed turned negative, and President Bush's PAI plunged. That divergence ultimately resolved itself in favor of the PAI, with the start of the Bear Market.


Stock Market Sentiment:

Traders:
The sentiment of short-term stock market traders, as measured by the Daily Sentiment Index (DSI), reached 94% bulls in November; the highest level since the 2007 all-time stock market peak.

The DSI stood at record low 2% bulls on 09 March 2009; the beginning of the current rally.

Individual Investors:
In December, the weekly survey of individual investors polled by the
American Association of Individual Investors (AAII) hit 63% bulls; the highest level since the October 2007 all-time high! The 10-week moving average of the percentage of bulls in the AAII poll was 49.3%; the highest level in six years!

AAII

Investment Advisors:
December Investors Intelligence (II) surveys of advisors reached 59% bulls; the highest level since the 2007 all-time highs.

Mutual Fund Managers:
Their current cash-to-assets ratio is 3.6% cash; slightly above the all-time low of 3.4% in July. A VERY BULLISH reading.

Bloomberg conducted a poll of the chief market strategists for 13 of the largest banks in the world. All 13 of them are bullish for 2011.

Barron's reported the results of its review of 10 of Wall Street's top institutional strategists and investment managers. All 10 are bullish for 2011.

Barron's conducted a similar survey in December 1972, and ran the cover story "Not a Bear Among Them" in its January 1973 issue. The stock market began a 50% bear market decline within a few days!

The 17 December 2010 issue of USA Today quotes five Wall Street heavyweights as saying its time for individual investors to get over their fear of the U.S. stock market.

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Remember, in the stock market, measures of extreme bullishness are an indicator of an impending top, and a major reversal.

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Conclusion:
The measures of sentiment reviewed above portray a great divergence between a gloomy outlook for the economy and the nation versus a rosy outlook for the stock market. Eventually, these differences should converge.

Either people will become more optimistic about the economy and the nation, following the lead of stock investors, or a major decline will begin in the stock market that will turn investors as bearish on stocks as people are on the economy and the nation.

Since similar stock market sentiment, in late 1972, lead to the 1973-74 bear market that took the averages down about 50%, and current stock market sentiment is more extremely bullish than in late 2007, which also lead to a 50% decline; the most likely way to unwind the current divergence in sentiment is to see a dramatic decline in the stock market in the coming months.

In short, the balance of the evidence says it is very likely that the second leg of the bear market will begin this year.  

DISCLAIMER:
THIS CONTENT IS FOR EDUCATIONAL PURPOSES ONLY and is NOT INTENDED AS INVESTMENT ADVICE!


The Information contained in this article reflects an analysis of market trends and conditions, and nothing contained in this article, or on this website should be interpreted as, or deemed to be, a recommendation to any investor, or category of investors to purchase, sell or hold any security.

Any investment decisions must in all cases be made by the reader, or by his or her investment adviser. Nothing contained on this website is intended as a solicitation for business of any kind, or for investment.

As a matter of law, INVESTMENT ADVICE may only emanate from members of the government-created monopoly of federally-registered brokers and investment advisers. The author falls into neither category.

In contrast, what you just read is simply INFORMATION, that was obtained from what are believed to be reliable sources. It is ALWAYS wise and prudent to undertake investment positions only after considering a wide variety of information and opinions, on the subject, and after consulting with those who are authorized to give INVESTMENT ADVICE, if so desired. Although consultation with "experts" may be helpful, everyone should do their own DUE DILIGENCE regarding ANYTHING that may affect their financial well being.

The author is an active participant in the markets, and may trade the securities that are discussed in this article, both before and after publication, and/or may have a long-term position in such securities. In other words, the author usually has a financial interest in the subject of the articles on this web site.



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