Global Investment Strategy
May 18, 2015 (Weekly Update)
Chris Haverland, CFA®, Global Asset Allocation Strategist
Weekly market insights from the Global Investment Strategy team
- Confidence among businesses, consumers, and investors has improved dramatically over the past six years. However, we would not consider current optimism survey results to be at excessive levels.
- Overconfidence (and under-confidence) can lead to poor decision making and often signal the end of a cycle.
What it may mean for investors
- As business, consumer, and investor confidence builds, it should support equity prices and cyclical sectors such as Consumer Discretionary, Industrials, and Information Technology.
Don't Mistake U.S. Swagger for Overconfidence
Merriam-Webster's dictionary defines optimism as "a feeling or belief that good things will happen in the future." Being optimistic about life, work, or even one's investments can have a powerful influence on decision making. If there is positive sentiment about the future, businesses may invest more, consumers may spend more, and investors may be willing to take on a bit more risk. Sometimes, however, being overly-optimistic (or pessimistic) can cloud one’s judgment and potentially lead to poor decisions.
Is optimism in the U.S. too excessive today? My answer would be no. Although sentiment surveys have shown sizeable gains since the depths of the financial crisis, results remain well below previous cycle peaks. Businesses remain cautious even with record profits and cash on their balance sheets. Consumers continue to drive the U.S. economy, but recent improvements in the labor markets and lower gasoline prices have yet to be reflected in a pattern of consistent consumer spending. Meanwhile, investors continue to be wary of stocks six years after the latest bull market began.
Chart 1. Consumer, Business, and Investor Confidence Measures
Source: Bloomberg, Conference Board, National Federation of Independent Businesses, AAII, 5/14/15.
The National Federation of Independent Business' (NFIB) Small Business Optimism Index rebounded in April to 96.9, but remains well below a previous peak of 107.7 reached in 2004. Even though small business owners appear more optimistic, the proportion of companies planning capital outlays in the next three to six months remains in the 20 percent to 30 percent range, compared to a 30 percent to 40 percent range in prior expansions. The employment component trend remains positive with plans among business owners to hire and/or to raise compensation inching closer to historical levels. However, none of these readings appear exceedingly sanguine.
Consumers also have shown improved confidence in the past few years in both the current conditions and outlook components of the Conference Board's Consumer Confidence Index. The last reading on confidence fell to 95.2, but the overall trend is intact—with anything above 90 considered healthy. Consumers are more optimistic about their employment situation, job prospects, income levels, and inflation expectations. Even so, the index remains below the peak from the last expansion and well below the high point reached in 2003. Simply put, there are no signs of irrational optimism here.
Investors also have exhibited some optimism during this recovery by allocating money to risky assets— pushing many equity indexes to all-time highs. This enthusiasm has been fueled by confidence in the corporate earnings outlook, with profits at record highs, and a highly accommodative Federal Reserve (Fed). Nonetheless, investor optimism, as measured by the American Association of Individual Investors' (AAII) Investor Sentiment Survey, reveals no excessive exuberance among investors, with a majority of survey participants maintaining a neutral outlook. This corresponds with still modest flows into equity mutual funds and valuations that remain fair relative to historical levels.
The Fed also can influence confidence. As it gradually removes policy accommodation, it will signal that the U.S. economy is healthy enough to withstand higher rates. In our view, a Fed rate hike later this year will be positive for the economy—and perhaps even the investor psyche—as it starts us down a path of rate normalization. Although businesses, consumers, and investors have come a long way over the past six years, we believe that there is still room for improvement. This, in turn, should translate into improved equity prices in those sectors in which building optimism can play a key role, such as Consumer Discretionary, Industrials, and Information Technology.
Chris Haverland is a global asset allocation strategist for Wells Fargo Investment Institute (WFII), an organization that provides global manager research and investment strategy advice to Wells Fargo’s Wealth, Brokerage, and Retirement (WBR) division. WBR is comprised of Wells Fargo Private Bank, Wells Fargo Advisors, Wells Fargo Institutional Retirement, and Abbot Downing businesses, accounting for more than $1.6 trillion* in assets under administration.
Mr. Haverland is responsible for thought leadership on the economy, financial markets, investment strategy, and asset allocation. He researches timely investment topics and produces market updates, special reports, white papers, podcasts, and webcasts that articulate strategies for clients that help them meet their long-term financial goals. Other responsibilities include developing capital market assumptions and strategic asset allocations, providing tactical advice, conducting asset class research, assisting in portfolio management, writing commentary for investment publications, and providing investment guidance for financial advisors and clients.
Prior to joining Wells Fargo, Mr. Haverland was a portfolio manager, corporate bond analyst and trader at Jefferson Pilot Financial (now part of Lincoln Financial) in Greensboro, North Carolina, where he managed $2.6 billion in fixed income assets. He has nearly 20 years of experience in financial services.
Mr. Haverland earned a Masters of Business Administration from Elon University and a Bachelor of Science in Business Administration from Appalachian State University. He is a CFA® charterholder and is a member of the CFA North Carolina Society. Mr. Haverland is located in Winston Salem, North Carolina.
*As of Sept. 30, 2014
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