3rd Quarter 2016 Commentary


On September 22nd, the American Association of Individual Investors (AAII) released their Sentiment Survey, which the reader will find below.


The bullish sentiment reading fell to 24.8% and remains 1 standard deviation below the norm at 28.3%.  The eight period moving average also fell.  A year ago we wrote that equity investors were unsettled.  They have continued to be.  There have been numerous pundits who have declared this seven year rally in most stock markets around the globe as one of the “most unloved”.

Skepticism/cynicism has been high.  “Animal spirits” have been absent as too many, twice burned by stock market “craters” since 2000, have refused to believe that “the bull” has any legs. Many investors have left the equity markets and have redeployed their capital into increasingly risky bond markets, searching for yield.  But stock markets have continued to trudge higher – not every day and not necessarily by a lot on any day – but higher. The following chart we find interesting as it looks at long term trends of investor sentiment and what has happened correspondingly in the US stock market as represented by the S&P 500.  The methodology is different from the aforementioned AAII as displayed in Chart 1, because Chart 2 combines the AAII sentiment measure (a retail investor look) with a gauge from Investors Intelligence (professional advisors) extracted from Thomson Reuters DataStream.


Please look at years when bullish sentiment has turned after a significant fall (e.g. 2009,2003 and 1994).  In those instances the S&P rallied significantly.  Now look at 2016 and please note the “turn” in “bullish” sentiment.  Retail investors might be feeling glum – but the “pros” might be sensing a change “in the wind”.

What could change attitudes?  At this juncture, we feel only one factor would be sufficient and satisfactory – corporate earnings growth. So far, equity markets have “ground higher” largely via the expansion of price/earnings (P/E) ratios.  P/E ratios are driven by investors to expand early in market rallies as investors become less fearful of market risk.  P/E ratios also expand as interest rates go down because bonds, the natural alternative investment to stocks, become more expensive as interest rates go down.  Thus stocks are allowed by investors to become comparatively more expensive.  But there does eventually come a time in each market cycle when P/E ratios can no longer expand only by themselves.  There comes a time when corporate fundamentals like earnings must reassert themselves in the calculation of an appropriate corporate valuation.

We believe we have arrived at that juncture in this market cycle. The E (earnings) in the P/E ratio must grow to shrink the P/E ratio and lend fundamental support to stock prices.  Fortunately, we think earnings are about to do just that.


Importantly from the chart above, we want the reader to note the directional change in earnings estimates from negative to positive year over year and to notice that the negative changes are becoming less negative and the positive ones more positive.  Throughout a year, analysts make earnings projections – usually the first projections are more positive than the later ones for any given quarter or year. It is human nature to be optimistic rather than realistic, until one has to be.  In the second quarter of 2016, the final number for earnings for the S&P 500 was revised down relatively little as compared to the first estimate for the quarter – that is, analysts got it right.  This was also the first time since Q3 2014 that the earnings were better than in the previous quarter.  In the third quarter, earnings are expected to be flat with the year ago mark (so no decline) and this would be another quarter of improvement quarter over quarter.  As to Q4, forecasts remain strong.  This could represent “the turn” in corporate earnings – enlarging the E in P/E and lowering the ratio, providing fundamental support for stock prices, besides a benign interest rate environment.

So to wrap our forecast with a neat bow, we think that current investor sentiment might be about to change to a positive view. Retail investors still are sour and not trusting of the market. Professional investors seem to be noticing a change “in the wind” and the cause for this change is earnings, which look to be turning up.


  • Economic growth will continue at a pace of around 2.5% – 3%     No – Growth has slowed
  • Inflation will remain quiescent     Yes – Nowhere to be seen
  • The dollar will stabilize, perhaps strengthen a bit more     Yes – Brexit has given a boost to the “Greenback”
  • During 2016, oil’s price will find a bottom not far away from now and will rally into 2017    Yes – Might be an OPEC production deal in November
  • Interest rates will rise – but the rate of increase will be slow     No – Not Yet
  • Political reform will grow in South America     Yes – Rousseff has been impeached & Venezuela could change government
  • It will be another “Banner Year” for mergers and acquisitions     Yes
  • Consumer spending will improve     Yes/No -On cars & houses, yes; on clothing, no
  • Émigrés will continue to be a “hot potato” politically around the world    Yes – Central point of Brexit disagreement and of political debate in U.S.
  • Amongst the popular investment alternatives, equities should do the best     No – Not yet, but still believe

q3photo4 q3photo5

The opinions expressed in this Commentary are those of Baldwin Investment Management, LLC.  These views are subject to change at any time based on market and other conditions, and no forecasts can be guaranteed.

The reported numbers enclosed are derived from sources believed to be reliable.  However, we cannot guarantee their accuracy.  Past performance does not guarantee future results.

We recommend that you compare our statement with the statement that you receive from your custodian.

A list of our Proxy voting procedures is available upon request.

A current copy of our ADV Part II & Privacy Policy is available upon request or at www.baldwinim.com/disclosure.htm