History Says: Sentiment Lows, Market Highs

History Says: Sentiment Lows, Market Highs

• December consumer sentiment rebounded from a near record low.

• Similar outcomes have precipitated stock market rallies.

• The Nasdaq Composite has averaged a 53% return over the next two years.

It’s hard to find the signal when you’re dealing with so much noise…

One of the hardest things to do as an investor is separate reality from a narrative designed to grab your attention. The current environment is no exception. Every day, headlines seem to offer a fresh reason for stocks to fall. It’s a pattern we’ve seen often: fear sells, and the loudest voices tend to be the most bearish. Yet quite often, they miss the turn.

Case in point: last week’s release of the University of Michigan’s preliminary consumer sentiment index for December. The gauge rebounded from one of the lowest levels on record. In November, the media framed it as an economic red flag. Last week, barely a peep was made about the reversal. But history tells us such a shift is bullish for investors.

When the University of Michigan’s Consumer Sentiment Index hits extreme lows, it often marks a turning point for Wall Street. Deep pessimism tends to show up when fear is peaking, and expectations are washed out. That’s not the start of a collapse, it’s usually the end of one. These moments reflect emotional capitulation. And in a market driven by expectations, that shift in mood can spark the next leg of a rally.

I’ve run the numbers. Based on what I found, troughs in consumer sentiment have consistently set the stage for strong gains in the S&P 500 and Nasdaq Composite Indexes.

But don’t take my word for it, let’s look at what the data’s telling us…

The University of Michigan’s Consumer Sentiment Index has tracked the mood of American households for nearly 75 years. Born in the aftermath of World War II, it was built to measure how people feel about their finances, the economy, and what’s ahead. Since the early 1950s, it has offered a steady read on consumer confidence through every kind of market cycle.

Each month, researchers at Michigan’s Institute for Social Research survey at least 500 adults across the U.S. They ask questions like: How’s your financial situation? Is now a good time to buy big-ticket items? What do you expect over the next year? The answers are distilled into three key measures: current conditions, future expectations, and the headline sentiment index. The data is weighted to reflect the broader population and benchmarked to a 1966 base year, making long-term comparisons easy.

Because consumer spending drives about two-thirds of the U.S. economy, the index gets a lot of attention. When sentiment rises, people tend to spend more. When it falls, they pull back. That makes it a useful gauge for policymakers, businesses, and investors alike. It doesn’t predict the future, but it does capture the public’s pulse.

When the index makes headlines, it’s usually because it’s hit an extreme. The media uses it to argue that the economy is either about to boom or bust. I see those extremes as contrarian signals. If the gauge is making a new high, how much better can things get? If it’s plumbing new lows, how much worse can it really be?

From an investing standpoint, I focus on the pessimism. When sentiment is in the gutter, the spending mood is more likely to improve than deteriorate. And that shift tends to drive demand—for goods, services, and stocks.

So, I went back and found every major trough in the Michigan sentiment index since 1952. Then I ran the total returns (with dividends reinvested) for the S&P 500 and Nasdaq Composite based on the closing price at the end of each month when a low occurred. The results were striking.

Let’s start with the S&P 500…

Following major sentiment lows, the index has averaged gains of 29% over the next 12 months and 47% over the next 24 months. That’s well above the long-term annual average of 9.5% since 1928. And in every one of those long-term cases, the market finished higher.

The Nasdaq’s record is even stronger…

While the index hasn’t been around as long, the data still packs a punch. After major sentiment troughs, the Nasdaq has averaged gains of 41% and 53% over the following one- and two-year periods, respectively. That compares to its lifetime annual average of 11%. And like the S&P, every one of those instances delivered a positive return.

So, like I said at the start: the headlines may be loud, but the data speaks louder. When consumer sentiment bottoms, it’s often a setup—not for more pain, but for a steady rally. The market doesn’t wait for everyone to feel good. It moves when expectations are at their worst and the noise is the loudest. And right now, that may be exactly what’s happening.

To see how I'd invest, check out the BentPine Growth Portfolio here.

Five Stories Moving the Market:

Federal Reserve Chair Jerome Powell is expected to push through another quarter-point interest-rate cut this week despite growing unease among fellow policymakers that inflation remains too high - Bloomberg. (Why you should care – Wall Street will be paying close attention to the Summary of Economic Projections guidance regarding the rate path outlook next year)

Chief executives of large European companies have become more bullish about investing in the U.S. than at home, according to a European Round Table for Industry survey; the group is downbeat on Europe's economic prospects, albeit less so than six months ago – Reuters. (Why you should care -  this goes against the popular media narrative that businesses and investors are fleeing the U.S.)

U.S. Trade Representative Jamieson Greer said China has been complying with the terms of the bilateral trade agreements and that the U.S. is constantly monitoring commitments made by China in a bid to maintain a stable trade relationship – Bloomberg. (Why you should care – trade representatives from the U.S. and China held a call last week to discuss maintaining stable ties and addressing concerns on trade)

The U.S. Office of the Comptroller of the Currency and the Federal Deposit Insurance Corporation said they are withdrawing their guidance on leveraged lending issued more than a decade ago, a move that contributed to the rise of private credit; the guidance was introduced in 2013 by the OCC, the Federal Reserve and the FDIC to curb the riskiest loans made by banks – Reuters. (Why you should care – the rule change could boost the banks’ lending capacity and profits)

Two popular ‘quality’ exchange traded funds have experienced wildly different performance after one ditched Nvidia and most of the rest of Big Tech while the other hasn’t; the $48 billion iShares MSCI USA Quality Factor (QUAL) and Invesco’s $15 billion S&P 500 Quality (SPHQ) have differing views about the accounting concept of accruals, a way to gauge how much of reported earnings are based on sales that generate cash right away, rather than money owed by customers in the future or other noncash items – WSJ. (Why you should care – MSCI decided against using accruals as it would create increase churn in its quality index; QUAL has outperformed SPHQ this year as a result)

Economic Calendar:

Earnings: TOL

China – Exports, Imports for November

Japan – Bank Lending for November

Japan – GDP for 3Q

Germany – Industrial Production for October (2:00 a.m.)

Eurozone – Sentix Investor Confidence for December (4:30 a.m.)

U.S. – NY Fed Consumer Inflation Expectations for November (11:00 a.m.)

Treasury Auctions $86 Billion in 13-Week Bills (11:30 a.m.)

Treasury Auctions $77 Billion in 26-Week Bills (11:30 a.m.)

Treasury Auctions $58 Billion in 3-Year Notes (1 p.m.)