So it’s official. Investor sentiment in the U.S. stock market has finally reached “euphoria,” according to Citigroup’s widely followed Levkovich Index. The index uses 11 different inputs to gauge how people in the market are feeling, and those indicators say investors are now a giddy crew.
What does this mean for sober, serious investors like you and me? The good folks at Citi warn that the index isn’t a short-term market-timing tool. Just because many investors are feeling unusually positive, and just because they might be unduly optimistic, doesn’t mean the market is going to immediately snap back to reality.
Once the U.S. stock market enters the euphoric zone, it has historically remained there for an average of 26 weeks before falling back to Earth, according to Citi. However, on some occasions – such as the 1990s tech bubble or the COVID-19 frenzy – the market has floated in euphoric territory for more than a year before reverting to normalcy.
Be that as it may, the core message of the Citi index seems clear: After a rip-roaring year in which U.S. stocks surged by more than 25 per cent and global stocks soared more than 20 per cent, we should now brace ourselves for a bumpier ride ahead.
It’s not that the North American economy is crumbling. But it is sending a flurry of mixed signals.
On Friday, for instance, Canada reported that unemployment jumped in March. Conversely, the United States published numbers showing job growth that vastly exceeded expectations.
Interpreting this can be difficult. From an investor’s perspective, the bad-news Canadian job numbers may be good news, since they suggest the Bank of Canada will soon start cutting interest rates to bring relief to a struggling economy.
On the other hand, the strong U.S. job numbers are a mixed bag for markets, because galloping growth in employment presumably feeds inflation. The strength of the job market suggests the Federal Reserve will have to keep interest rates higher for longer to avoid overheating the economy.
Making this picture even murkier are worries about the quality of the data itself. One continuing puzzle has been the big gap between how the U.S. economy looks when viewed from two competing perspectives: gross domestic product (GDP) and gross domestic income (GDI).
In theory, these two ways of measuring output should give exactly the same result. GDP gauges the size of the economy by measuring how much everyone has spent. GDI gauges the size of the economy by measuring how much everyone has earned.
The two measures have historically diverged only slightly, for technical reasons to do with data collection, but recently that close relationship has broken down.
Over the past year or so, the twin gauges have gone their separate ways. “Whereas GDP claims that the second half of 2023 was a period of remarkable growth, GDI thinks the economy utterly stagnated,” writes Eric Lascelles, chief economist at RBC Global Asset Management.
Which one of these indicators is right? Nobody knows, but the discrepancy offers good motivation to keep your eye on other signals. Three in particular are keeping me up at night.
The first is the number of temporary workers in the economy. In the past, a substantial fall in temp staff has provided one of the most reliable early warning signs of a U.S. recession ahead.
Will it do so again? Over the past two years, U.S. companies have shed about 400,000 temporary workers. A decline of that magnitude typically happens only before a downturn.
A second indicator to monitor is the year-over-year change in how much banks are lending to commercial and industrial borrowers. The volume of these loans usually grows in a healthy economy. It shrinks only during recessions or their aftermath.
It’s remarkable, therefore, that the volume of U.S. commercial and industrial loans began to contract late last year. This does not fit with the widespread notion that the U.S. economy is booming.
A final area to watch is delinquency rates on consumer loans. The Federal Reserve Bank of New York tracks this data and recently found that delinquency rates on credit cards have climbed past prepandemic levels for most age groups. Much the same is true of auto loans, where delinquency rates “have pushed past pre-pandemic levels and the worsening appears to be broad based,” according to researchers.
Could the U.S. consumer finally be tapped out? That’s tough to say, but the rise in delinquency rates adds to the evidence that the stock of excess savings accumulated during the pandemic is now close to exhausted.
To be sure, none of these downbeat numbers have to portend disaster. It’s easy to point to other numbers – such as the booming job numbers on Friday – as evidence that the U.S. economy is doing just fine.
However, the collective message of all these indicators is that investors should not expect a repeat of the past year’s big gains. The falling number of temp workers, the decline in commercial loans, the growing delinquency rates on consumer credit and the discrepancy between GDP and GDI suggest a gap is growing between the euphoria on Wall Street and the more complicated reality on Main Street.
Ian McGugan