Examining forward returns for domestic equities following a move to #1 in DALI, as well as the latest AAII Sentiment Survey results.
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Earlier this week, domestic equities moved into the top-ranked position on our Dynamic Asset Level Investing (DALI) tool. This change has been touched on in various research articles throughout the week and will be a key point of today’s featured article as well. While the movement of domestic equities into the top position has not been surprising, the timing of the movement has raised some questions from our clients. It took a total of 116 market days for domestic equities to move from its COVID-induced low ranking of fourth out of the six broad asset classes on March 16th to the top position on August 25th. It is important to keep in mind, however, that changes on the DALI broad asset class rankings do not occur very often, as the tool is meant to be a long-term view of where relative strength lies across markets.
There have been seven instances where we have seen domestic equities transition back into the top-ranked asset class, including the most recent occurrence, throughout the history of the broad asset class rankings, which dates back to 12/31/2002. In order to examine how domestic equity markets typically fare following a move to the top of the DALI rankings, we pulled forward return data for the S&P 500 Index SPX from each historical date where the asset class regained leadership. In keeping with the long-term nature of the DALI tool, we see SPX typically show relatively muted losses on a near-term basis after a shift into the #1 ranking, however, the market benchmark typically displays significant gains three months down the road, with an average return of 3.36%. These returns are amplified as the time horizon expands, with an average return of 11.66% six months after taking the lead and an average gain of 15.57% over a one year forward return basis.
While these averages paint a positive picture for the long-term view of domestic equity markets following this week’s shift in relative strength, we are working with a small sample size for our examination. Every market environment is going to be different, and the environment in which we currently find ourselves certainly feels unique.
Even as major domestic equity indices have surpassed all-time highs, many investors are still doubtful that this recent rally will be sustained. This is displayed through the American Association of Individual Investors Sentiment Survey, which we track on the NDW system through the AAII Bull-Bear Spread AAIISPREAD. This reading depicts the percentage of those that are bullish in their market outlook minus those that are bearish, and based on the latest numbers that were released Thursday, we still have more bears than bulls as the reading sits at -7.54%. In addition to the normal chart of this reading, we have also taken these readings and smoothed them out via a 4-week moving average shown on the AAIISPREAD4WK chart. With data from this week, the 4-week average comes in at -13.99%, which did lead to a reversal up on the chart to -14. In looking at the history of this reading compared to price levels of the S&P 500 Index, we have never seen the 4-week spread this low while the market sits at all-time highs. Other times when the reading was low and SPX was near highs include February 1991, September 1992, and May 2013, which were all in the midst of prolonged periods of growth for domestic equities.
