We’re in the Money? An Analysis of Current Market and Investor Sentiment

By Scott Welch, CIMA®, Chief Investment Officer & Partner

Reviewed by Carter Mecham, CMA®, IACCP®

As we near the end of 2024 and given the market “melt-up” over most of the year, it seems a good time to visit and discuss current market and investor sentiment.

As a quick reminder, while market fundamentals (valuations, earnings, quality, dividends, etc.) are supposed to drive longer-term performance, in the short run prices are heavily influenced by momentum and investor sentiment. 

We thought this blog was timely because we are becoming increasingly concerned about market and investor complacency. Even before the election of Donald Trump, the market seemed to shrug off any bad news and just continue to rally.

Since Trump’s election, the market seems to be almost in a state of euphoria, believing he will sweep in a more growth-oriented regulatory and tax regime. On the other hand, the market seems to be downplaying any economic and inflation consequences of his proposed tariff policies. 

We are on the record saying we don’t like tariffs as an economic policy – they have rarely if ever been successful other than as a threatened “sledgehammer” approach to gaining concessions from trading partners. Perhaps Trump’s stated agenda is simply a negotiating tactic, but if it is not there will be unintentional negative consequences.

Furthermore, given the narrow Republican majorities in the House and Senate – and the compromises that will require with Democrats to get anything meaningful regulation passed – the market may be overestimating exactly how much can and will be done.

The Fed cuts rates by 25 bps at its November FOMC meeting, as expected, but has now seemingly embarked on a “cut and pause” approach. The economy, inflation, and labor markets simply do not support a continued aggressive rate cut regime at this time.

As a possible example of market complacency, we saw a sharp sell-off following the somewhat “hawkish” December FOMC meeting, combined with the startling collapse of the Congressional “Continuing Resolution” (“CR”) budget deal following very public disapproval from Trump and Elon Musk. 

In particular, Musk reached out to his 200 million followers on X and asked them to inundate their respective Congressional representatives expressing their disapproval of CR – which subsequently fell apart. If a new budget deal is not passed the Federal government will shut down over the holidays.

And then the market regained its footing and began rising again the very next day!

One main driver of current market optimism is the continued resilience of the economy and the increased belief that we may avoid a recession.

Q4 GDP is now estimated at plus or minus 3% – not necessarily robust but still positive.

Source: Atlanta Fed “GDPNow Estimate,” as of December 18, 2024. This is an estimate and subject to change. 

A second driver is earnings – the Q3 earnings season was solid and Q4 is expected to continue the trend, albeit at lower positive rate. Earnings are then expected to accelerate as we move through 2025.

Source: Zacks Research, as of November 22, 2024. The green bars represent earnings, and the orange bars represent revenues. The hatched bars are estimates and subject to change. You cannot invest in an index and past performance is no guarantee of future results. 

The above chart shows earnings expectations for the S&P 500 index, and investors should keep in mind that those projections are very much influenced (and skewed upward) by the top ten “mega-cap tech” stocks.

So, the economy is moving along, earnings seem healthy. What about valuations? 

Here the market may have reached a tipping point considering the year-long “melt up” in the stock market, especially among the mega-cap tech stocks. Small and mid-cap stocks are not trading out of historical valuation ranges, but large cap stocks – even without the crazily “frothy” mega-cap tech stocks – are getting increasingly expensive. 

Sources for both charts: Yardeni Research, as of December 17, 2024. You cannot invest in an index and past performance is no guarantee of future results. 

At the November FOMC meeting, the Fed signaled it would remain highly “data dependent” and needs to see further progress on inflation before initiating more rate cuts (signaling we may see only 2-3 over the course of 2025). This was viewed negatively by the market as it was hoping for a less “hawkish” signal from the Fed but, in our opinion, it is the appropriate course of action.

All this translates into continued investor optimism. We might argue that complacency still seems to be the mood of the day, and that “FOMO” (fear of missing out) is driving continued market momentum, and we might be right. 

The Bank of America posted an analysis recently indicating that investor cash holdings are at their lowest level in three years – and most of that cash has flowed into the stock market. 

Source for all four charts: Bank of America and The Daily Shot, as of December 16, 2024. You cannot invest in an index and past performance is no guarantee of future results.

History shows us that sentiment and momentum can drive market performance long past what seem to be reasonable valuations and fundamentals. So, the current market rally may continue for some time – but it won’t last forever.

We expect to see increased volatility for the remainder of this year and at least through inauguration day in late January.

With that as a backdrop, let’s take a dive into market and investor sentiment. 

1. Market Volatility  

As measured by the “VIX,” the market remains as complacent as it has been since the pre-Covid days back in 2020 (when interest rates were still hovering around zero), implying continued low investor concern about any impending significant market correction. 

[The spike on December 18 was due to disappointed investors following the FOMC meeting and seemingly “hawkish” signals from the Chairman Powell in his post-meeting press conference, combined with the collapse of the CR budget deal.]

Source: Ycharts, as of December 18, 2024. You cannot invest in an index and past performance is no guarantee of future results. 

2. Retail Investor Sentiment  

The American Association of Individual Investors (AAII) publishes the “AAII Bull-Bear Spread,” the results of a weekly survey of the optimism or pessimism of individual investors regarding the direction of the stock market. 

History suggests retail investors are notoriously bad market timers, so this survey may serve as an interesting “contraindicator” to future market movement. 

We see that sentiment has somewhat stabilized over the past few months but remains elevated (bullish) versus historical levels.

Source: AAII and Ycharts, 5-year data as of December 12, 2024. 

3. Institutional Investor Sentiment  

Theoretically, institutional investors are more “savvy” than retail investors, so what they think is a relevant input. 

State Street Global Markets publishes a monthly “Risk Appetite Indicator” which tracks institutional investor fund flows — that is, not how they “feel” about the market but how they are actually positioning their portfolios.

 Source for both charts: State Street Global Advisors’ “Risk Appetite Index,” through November 2024. 

Flows increased and cash holdings remained stable in November, indicating continued market confidence by institutional investors.

4. Equity Sentiment  

Goldman Sachs regularly published an “Equity Sentiment Indicator” illustrating how investors are positioning their portfolio. A “stretched” positioning indicates that investors are allocating more to equities than historical averages. 

Source: Goldman Sachs and the Daily Shot, as of November 2024. A “Z-score” measures how many standard deviations from the historical mean a particular measurement is. In this case, the positive Z-score indicates that investors are allocating more money to the equities than the historical mean allocation. 

We see a similar illustration from Deutsche Bank.

Source: Deutsche Bank and the Daily Shot, as of November 2024. A “Z-score” measures how many standard deviations from the historical mean a particular measurement is. In this case, the positive Z-score indicates that investors are allocating more money to the equities than the historical mean allocation. 

The market remains infatuated with all things associated with artificial intelligence (AI), as can be seen by investors’ positioning of the mega-cap tech stocks within their portfolios.

Source: Deutsche Bank and The Daily Shot, as of December 17, 2024. A “Z-score” measures how many standard deviations from the historical mean a particular measurement is. In this case, the positive Z-score indicates that investors are allocating more money to the mega-cap tech stocks than the historical mean allocation. 

Another sentiment indicator, however, shows a different picture. The CNN Business “Fear and Greed” index shows that investors have moved into a “fear position – perhaps because of high valuations and increased uncertainty over future Fed policy. 

Source: CNN Business, as of December 18, 2024. The Fear & Greed Index is a compilation of seven different indicators that measure some aspects of stock market behavior. They are market momentum, stock price strength, stock price breadth, put and call options, junk bond demand, market volatility, and safe haven demand. The index tracks how much these individual indicators deviate from their averages compared to how much they normally diverge. The index gives each indicator equal weight in calculating a score from 0 to 100, with 100 representing maximum greediness and 0 signaling maximum fear. 

5. Put / Call Ratio 

As a final measure of market sentiment, we look at the Chicago Board of Exchange (CBOE) “Put / Call Ratio,” which measures how options investors are behaving and trading. 

A high ratio (>1) means more put options (the right to sell stocks) are being purchased than call options (the right to buy stocks), suggesting a bearish investor outlook. 

Conversely, a low ratio (<1) implies more call options are being purchased than put options — suggesting a bullish outlook. 

As with the other sentiment indicators, aside from CNN, the current indication is that investors remain bullish on the market. 

Source: The CBOE and Ycharts, as of December 18, 2024. You cannot invest in an index and past performance is no guarantee of future results.

Summary and Interpretation 

What these various market sentiment indicators continue to tell us is investors remain optimistic about future equity market performance. 

Why the market optimism? There certainly are reasonable arguments: 

1. A generally positive outlook for the global economy, particularly in the US.

2. Though it may slow down its pace, the Fed has not suggested it plans to halt its rate cut regime. 

3. An opinion that, if earnings hold up as expected, they will continue to support the current elevated market valuation levels; and 

4. Continuing that thought, a general view that earnings will come in reasonably well for Q4 and then accelerate as we move through 2025. 

What does not seem to be priced into current market levels? 

1. Any deep concern over simmering geopolitical tensions with Russia, Iran, and China, the ongoing wars in Israel and Ukraine, and now the recent insurrection in Syria and political unrest in South Korea, Germany, France, and Canada. 

2. Any concern over whether the incoming Administration will be successful in its efforts to control the border, reduce regulatory and tax burdens, and implement an aggressive tariff policy. With narrow majorities in both the House and Senate, we believe there is a risk that changes in Washington, DC may not meet investor expectations. 

3. The mega-cap tech stocks continue to represent ~30% – 40% of the overall market capitalization of the S&P 500 index, meaning any decline in these stocks will have an oversized impact on overall index level performance. 

These companies must maintain healthy revenue and earnings growth to justify their elevated valuations. While margins and earnings generally held up in 2024, most or all these companies run the risks of (a) AI not resulting in the almost magical benefits that are being priced in, and (b) being leapfrogged by smaller and more nimble firms better able to exploit the next generation of AI.

We are not bearish on the markets per se but continue to believe we are in for surprises that the market, for now, is not pricing in. Specifically, we anticipate increased volatility between now and at least the end of January.

We believe the market can continue to rally from current levels, but almost certainly not at the rate it has over most of the past twelve months. 

Many analysts have upwardly revised their “price targets” for the S&P 500 index for 2025 but are calling for only modest levels of further price increases from this point forward. 

At some point the market adage is true – how much you can earn on any investment is at least partially a function of what you pay for it today. 

Given today’s valuations, we believe we will begin to see this phenomenon play out as we move through 2025, no matter how confident the market currently seems to be.