The Nasdaq is firmly in correction territory following a -13% decline while the S&P’s -9% drop is close. Contrary to popular belief, the market leads the economy, not the other way around. We’ve seen early signs of the flow through to the economy, with companies cutting capital spending and consumers pausing travel. Fortunately, the level of resulting bearishness has historically been a buying opportunity, with forward returns north of 20%.
Investor sentiment has dropped sharply on rising concerns of a slowdown in economic growth. The AAII Bull Index, which reflects weekly sentiment of individual investors towards the market over the next six months has dropped 19.3%, a level consistent with 2% of all readings since 1987. Analyzing prior periods of investor sentiment at or below current levels suggests these instances are typically a strong signal that a bottom is forming. Importantly, forward 12M average returns have historically been strong with the S&P 500 +22% (90% win rate) and Russell 2000 +20% (85% win rate), reinforcing the idea that time, not timing, leads to wealth creation.
There are many reasons to fear that growth in the US may be set to soften. New policies regarding tariffs, DOGE, and immigration are creating uncertainty at both the consumer and corporate level. Recent data from Apollo and the Conference Board suggests consumers are pulling back on vacation plans, expect lower job availability moving forward, and are less optimistic about their income prospects. Corporations are beginning to reverse course on capital spending budgets and the Atlanta Fed’s GDP forecast is now in negative territory for the first time since 2022. The market is a discounting mechanism that reflects this weakening. What’s not discounted is any oncoming positive reaction to counter the weakness. The probability of a May rate cut surged to 54% and the market is now expecting ~3.5 rate cuts this year vs the Fed’s guidance of 2. Further, the ~60bps drop since mid-January in the 10Yr, which tends to lead an acceleration in the economic surprise index by two months, could lead to improving macro conditions in the coming weeks. While the Trump administration has been more tolerant of weakness than previously assumed, we believe there are limits to their tolerance.
The potential for a broader growth scare has led to a sharp deterioration in investor sentiment. VIX call buying and S&P 500 put volume are both near record-highs while the AAII Bull Index is down to 19.3% after peaking at 52.7% in July 2024. Readings below 19.5% have only been registered 42 times since 1987 (2% of all instances), the bulk of which occurred in 10 periods of market volatility. In 8 of the 10, the bottom was already in and/or the bull market continued. Meaning, bearish readings of this magnitude rarely coincide with a market top.
Historical forward returns from similar levels are strong. The S&P 500 on average returned +2% in the forward 1M, +5% in the forward 3M, +11% in the forward 6M, and +22% in the forward 12M. Results for the Russell 2000 were similar, averaging +1% in the forward 1M, +6% in the forward 3M, +13% in the forward 6M, and +20% in the forward 12M. The max 12M drawdown was -5% on the S&P 500 (vs -4% since the index fell below 19.5% on February 27th) and -10% on the Russell 2000 (vs -6%), suggesting a worst case forward 12M return is largely priced in. Importantly, extending your time horizon not only led to strong returns but increased your probability of making money (90% win rate for the S&P 500 and 85% for the Russell 2000 over the forward 12M period).
Data source: Bloomberg and Patient Capital Management
The views expressed in this commentary reflect those of Patient Capital Management analysts as of the date of the commentary. Any views expressed are subject to change at any time, and Patient Capital Management disclaims any responsibility to update such views. There is no guarantee that market trends discussed herein will continue. It should not be assumed that any purchase or sale decisions will be profitable or will equal the performance of any security mentioned.
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