The Rising Tide of Confidence

In the few short days of 2011 some themes are already emerging. One such theme is that of upwardly revised growth forecasts for the United States. Big names are on board calling for growth in the 3 – 3.5% range, which happens to be a significant amount of cushion between the “line of economic sustainability in the sand” at 2.5% growth. Especially since so many had believed (and still do believe) the US would muddled through the next couple years, at best.

Global manufacturing data out this week is adding to the already half-full glass. Reports from Europe, the UK and Asia are all doing their part in bolstering snowballing confidence. In our piece last month titled “All swans are white again.” we said this:

Elliot Wave notes that S&P futures traders are the most bullish they’ve been in 4 years! Other sentiment surveys indicate even more bullishness among individual investors.

Anyway … much of the optimism likely stems from unusual improvement in usual economic data. Besides some improvement in manufacturing numbers et al, there seems to be improvement in sentiment numbers too. Small businesses optimism is steadily, albeit slowly, improving. A growing number of CEOs of major US companies expect to see sales growth, increased capital spending, and payroll additions over the next six months.

But the holidays are over now. Will sentiment shift? Investor sentiment readings suggest that at least a near-term move away from risk appetite is much overdue. Even a high tide must ebb at some point.

S&P 500 Daily: was yesterday the blow-off day to mark an interim high? Back in November it was cause for correction …

Might consumer sentiment readings indicate something different?

S&P 500 vs. Consumer Sentiment Index:

There is a bit of disconnect in the nearby comparison. Over the last decade the market tends to lag consumer sentiment readings, particularly on the downside. Right now the S&P is zooming right along while consumer sentiment has not yet made new highs. Three things could happen from here:

1) Improving economic forecasts and data reports could lead to improved consumer sentiment.
2) The market has overshot expectations for the real economy and will turn over as consumer sentiment stagnates or becomes worse.
3) The real economy zooms and the stock market gets whacked. (That would be the kind of surprise Mr. Market likes to deliver.)\

It’s not surprising to see this bit of divergence: the US consumer still has a lot of weight to bear in falling home values, high unemployment and household debts while investors are leveraging up on margin to buy stocks so they don’t miss any more of this almost 2-year long bull market.

Indeed. It has been impossible to swim against the steady flow of capital into risk. At this point it makes sense to know the risks to mob optimism and be nimble enough to react if these risks bite down. That could come soon:
S&P 500 Daily Wave Count:

We all know what kind of sentiment drives a Wave 5 move, right? Let’s just say, if you feel like you don’t want to miss any more upside, hold off for now. Fibonacci projections on this wave chart if it makes you feel any better about sitting tight …
S&P 500 Daily Wave Count with Fib Projections:

If you watch the stock market for clues into timing other assets, as we sometimes do, then consider this:

1) The last two weeks have seen the negative correlation between the dollar and equities return. So in the event of a short-term hit to optimism, the dollar could become the recipient of risk-averse capital flow.
2) On the same token, if only a correction ensues and risk appetite remains healthy across the globe and the negative US dollar/risk appetite correlation holds, then the dollar likely moves lower (breaking down out of a sort of narrowing wedge pattern on a weekly/monthly chart.)
3) But, if the upwardly revised US economic forecasts gain support from new data and bolstered confidence, then the US dollar could become an intermediate- to long-term recipient of capital based on a growth surprise (specifically the improving growth differential as we discussed yesterday.)
4) Or something else …!
5) Or something else …!

S&P 500 Futures vs. VIX (Volatility Index) Daily:

S&P 500 Futures vs. VIX vs. Gold (everybody loves gold): Gold getting whacked today. Stocks due to follow? Stay tuned.

We’ve said it before and we say it again: If the real economy in the US improves we think gold could be toast. Why?

 Liquidity drains from financial assets to real assets.
 Interest rates compete on zero yield gold.
 Overall systemic risk falls if the US economy improves.

But, many have called a top in gold to their trading account detriment. At least this time we will have reasons for getting burned … if we do.