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Why 'dumb money' has been right on the stock market

In this article:
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Schwab Chief Investment Strategist, Liz Ann Sonders, joins Yahoo Finance to discuss the lack of reaction in the market after the release of the CPI data and her article ‘Whole Lotta Love: Sentiment’s Potential Warning.’

Video Transcript

[MUSIC PLAYING]

JULIE HYMAN: About 15 minutes into the trading session. Little change, not seeming to be too fazed by the CPI print this morning, which came in hotter than estimated, all three major averages not even down 1/10 of 1%, which brings me to Liz Ann Sonders' latest note. She gets the lead out. It's called "Whole Lot of Love." And it's about sentiment in the market here. Liz Ann Sonders, of course, is the Schwab chief investment strategist. She's with us now.

So Liz Ann, when you look at those numbers that we got this morning and look at the reaction we're seeing, lack of reaction, in the stock market, what does that tell you about sentiment? And is that sort of in line with what you've been seeing?

LIZ ANN SONDERS: Well, certainly, CPI wasn't in line with what anybody was expecting. It's always hard to judge what is essentially 20 minutes of a market open. We make these assumptions about what the market sort of should do in the face of economic data that comes in either hotter or weaker than expected. But there's so many moving forces that define that.

I think the CPI thing may be that the market is looking through is, rightly so, there's been a lot of tension on the used car prices piece of it. Excluding used cars-- and maybe that's not an exercise we should ever do-- instead of core being up 4 and 1/2 percent, it's up 2.7%. And I heard in one of the segments before this one about the Manheim index not showing the same increase.

So you can massage the data little bit and come up with a slightly more benign story. But again, the market's got lots of forces driving it. And I'm not surprised on any given day what the market does in the short term.

MYLES UDLAND: Liz Ann, something you surfaced in your latest note is CEO confidence has really skyrocketed over the last several months. But as you kind of attached to this note, when confidence is that high, typically we don't see these kinds of huge gains from the S&P that follow. I'm curious how you're thinking about this setup against the backdrop of what has been described in the last few months as a peak growth environment when you look at likely the GDP and ISM and so on and so forth.

LIZ ANN SONDERS: Yeah. So I do think we are facing not peak growth in level terms but peak growth rate, both for the economy and earnings. And that's just simply the base effects from second quarter of last year. And I think CEO confidence, which is highly correlated to corporate profitability, is tied to that, given that Refinitiv expectations has second quarter year over year earnings growth for the S&P now approaching 70%. But the likelihood that that's the peak is there.

And I think when you look back at past highs and CEO confidence, you could do the same thing with consumer confidence, and then you look at periods where corporate profit growth has been stratospheric, you tend to have weaker corresponding returns for the equity market largely because the market has a discount mechanism at that point, has already priced in a lot of what we are now in the process of seeing in the second quarter.

So I think this environment of the market having moved ahead to some degree of the news that we're seeing right now is in keeping with patterns historically. A greater extreme in this environment because of the vagaries of COVID, but somewhat in keeping with typical patterns.

BRIAN SOZZI: Liz Ann, let's stay on your note. I like how you talk about the dumb money. How would you define the dumb money? And where do you see them invested right now?

LIZ ANN SONDERS: All right, so I always make it very clear when I show the chart that I had in that report which is data real time gauges from Sentiment Trader, that company. They put it together because I don't want to ever have some attachment to me of calling, say, retail investors dumb money, quite the contrary.

But what those indexes measure is, in the case of what they call the smart money, it's the big commercial hedgers, the big speculators in the index futures market versus the so-called dumb money being more on the odd lot side, small lot speculators in the equity futures, and a number of other factors. And those are real money gauges. They're not attitudinal, survey-based measures of sentiment.

Typically at extremes, you want to go against what the so-called dumb money is doing and vice versa in the case of the smart money. But what's been interesting in the past year or so is dumb money positioning has actually been correct. Staying bullishly positioned has been the correct move.

More recently, you've seen the smart money kind of step up and start to increase long exposure. And you're seeing that in other measures as well. But if you look back though to, say, the beginning of 2020, beginning of 2018 in the immediate aftermath of the COVID bear market, those extremes did work in favor of where the smart money was positioned and against where the dumb money was positioned.

It's just not been as typical in this past year, maybe because of sort of the rise of the newly minted day traders and the power that retail investors have had and have shown, so far anyway, as having been accurately positioned on the bullish side.

JULIE HYMAN: And so Liz Ann, when you take sort of the ensemble of all of these various sentiment indicators, what then? What conclusion--

LIZ ANN SONDERS: Yeah.

JULIE HYMAN: What's the big deal here?

LIZ ANN SONDERS: Well, I always caveat any discussion about sentiment with, yes, we can find times, like now, where most sentiment indicators are on at least toward extreme optimism end of the spectrum. And we know sentiment at extremes is a contrarian indicator. The problem is timing.

And sentiment, in and of itself, doesn't generally mean that the market is imminently going to move in a contrarian fashion. Typically you have seen or need some sort of catalyst. And in addition to that, breadth. If breadth is relatively healthy, it can be an offset to bullish sentiment conditions.

And we learned from the '90s that sentiment can say extremely optimistic for an extended period of time certainly absent a catalyst. So it's there as a potential risk factor. But it doesn't imminently suggest it's a threat to the market, not to mention the fact that a lot of where you're seeing the most egregious speculative excess has been in areas outside the traditional broader averages, be it in crypto or SPACs or nonprofitable tech or heavily shorted stocks, the meme stocks, et cetera. So that's not a bad backdrop where the really, really heightened speculation is in these non-traditional kind of hot pockets of the market.

JULIE HYMAN: Yeah. And a lot of the speculation seems to have come off in those various areas that you're talking about. Liz Ann, it's always good to catch up with you. Liz Ann Sonders, Schwab chief investment strategist, thank you.