Hello, Animal Spirits

The 'animal spirits' are coming back... The recent market action... Speaking a bull market into existence... The greed tide is rolling in... A two-sided takeaway... Last call to catch our AI event tonight...

The 'animal spirits' are awakening...

Back in the January issue of our Portfolio Solutions products, Stansberry Research Director of Research Matt Weinschenk quoted a famous phrase that the economist John Maynard Keynes wrote roughly 90 years ago. The stock market is driven, Keynes said, by...

... animal spirits – of a spontaneous urge to action rather than inaction, and not as the outcome of a weighted average of quantitative benefits multiplied by quantitative probabilities.

To which Matt explained...

In other words, people start buying stocks because they feel like it, not because they've updated their spreadsheets and rationally changed their minds.

In the spirit of this idea, today it feels and, importantly, looks like more and more animal urges are getting put into action as we speak.

The major U.S. stock indexes have been mostly ripping higher for months and gained again today... The benchmark S&P 500 Index is up about 11% since a notable low on May 24... The tech-heavy Nasdaq Composite Index is up even more, 15%, in the same period.

Both are up even higher since their October 2022 lows. And they're suddenly within 5% and a little more than 10%, respectively, of new all-time highs. In Keynes' parlance, the market has been "spontaneous" and "active" for a while now. And from what I (Corey McLaughlin) am seeing, the action may keep going until further notice.

A few notable new trends have emerged lately...

Smaller-cap stocks have outperformed large-cap names over the past month. The Russell 2000 Index, with a median market cap of less than $1 billion, is up 7% versus the S&P 500's roughly 4%. That means smaller growth-oriented stocks have moved higher as of late compared with the largest-market-cap companies.

As Matt wrote back in January, this behavior – small caps outperforming large caps – is among those you would want to see if the "animal spirits" were indeed awakening and higher prices were likely to be ahead.

We'll want to see this action persist to say that the spirits are fully back, but it's worth noting this shift already, especially in the context of all the other bullish action this year.

Like 'everything else' heading higher...

Hat tip to technical analyst Louis Spector for this following observation noted in yesterday's edition of the Daily Chart Report technical-analysis newsletter.

He showed the recent performance of the Vanguard Extended Market Index Fund (VXF), which tracks roughly 3,700 stocks – nearly all the regularly traded U.S. stocks except those in the S&P 500...

The index is now trading above its August 2022 "bear market rally" high for the first time, following what the S&P 500 Index did last month. So much for the idea that only the "Magnificent Seven" stocks are going higher.

Even an index without them is making higher highs.

There's more...

According to the Russell indexes, growth stocks have outperformed value by a substantial 25% over the past six months. And high-yield bond spreads – an indicator of investors' appetite for risk – have fallen since March's bank crisis.

Those are two indicators Matt also suggested following in January's Portfolio Solutions.

All the while, market "fear" – if you are to use the CBOE Volatility Index ("VIX") as a guide, which measures implied volatility based on options bets on the S&P 500 – dropped below pre-pandemic levels for the first time in June. And it's still there today after a brief spike.

Now, suddenly (and admittedly anecdotally), the folks on financial television are giving up on the "narrowness" of the market argument (which we've been debunking)... They've moved on to making a "broadening of the rally" the most popular idea.

They just might speak it into existence. That's how this can go sometimes.

We've talked before about the primary market emotions being 'fear' and 'greed'...

These emotions are at the heart of bull markets, bear markets, and what the pseudonymous author Adam Smith described as "The Money Game" in the classic 1960s book of that title.

Here is what Smith – whose real name was George Goodman, the late former editor of the journal The Institutional Investor – wrote about bull markets...

In rising markets, you can almost feel the greed tide begin. Usually it takes from six months to a year after the last market bottom even to get started. The greed itch begins when you see stocks move that you don't own. Then friends of yours have a stock that has doubled; or, if you have one that has doubled, they have one that has tripled. This is what produces bull market tops. Obviously no one rationally would want to buy at the top, and yet enough people do to produce a top.

If October was the last market bottom, we're almost a year from it. And today, it certainly looks like a "greed tide" is washing about the stock market. And that's two-sided, as Smith/Goodman alluded to.

Prevailing bullish sentiment can push prices of various assets higher than you might think is possible and grow your portfolio. But greed also inevitably sets the stage for an eventual downer, too, once the euphoria wears off... or something unexpected wrecks the mood.

Prepare accordingly. As always, make sure you know your investing goals – and align your portfolio to match them and the risk you want to take as best as possible. Today, that may mean adding to an allocation of stocks, while remembering, as we wrote last October...

Bull markets, or the speculative frenzies like we saw over much of the past two years, are great if you take them for what they are: good opportunities to make money. Just remember... the good times that won't last forever.

Of note, market breadth, which has been about average over the past several months – meaning not too bullish or bearish – has stretched higher to a point where buying right now could be risky.

Roughly 70% of S&P 500 stocks are already trading above their simple long-term, 200-day moving averages. This is the highest level since mid-February, which coincided with a short-term "top" for the benchmark S&P 500 Index around that time.

In the short term, a breather for this market run is certainly possible.

And longer term, we don't need to tell you about the risks of a recession... including a possible unemployment spike... sticky inflation... or the next credit crisis ahead. These are all things to prepare your portfolio for.

Plus, the "inverted yield curve" environment – reflective of inflation still being too high and a Federal Reserve being comfortable continuing to raise short-term lending rates – has been deepening for a year now and has yet to unwind.

At some point, it will, because the Fed will signal it's going to cut rates because the economy "needs" it... If and most likely when that happens, the relevant history we have from similar high-inflation/long-yield-curve inversions in the 1970s and early '80s suggests the S&P 500 could fall in the neighborhood of 13%. As we wrote last month...

That's not the worst pullback in recorded history, but it's notable.

Based on history, this would happen upon the elusive Fed "pivot" and rate cuts (which historically have also ended bear markets).

But until that happens, asset prices could keep going higher.

These spirits and fears can be powerful...

Let's go back to January again...

At the time, I would argue that most folks with money in stocks were extremely sour on the markets after seeing double-digit drops in the major U.S. indexes in 2022 paired with a rout in bonds and almost every other asset class.

Widespread fear about a recession ahead in 2023 was a prevailing headline, due to a substantially higher-interest-rate environment engineered by the Federal Reserve... the consequences of which would be unknown – and still are, frankly...

But as Matt shared back then, a few big contrarian thoughts were worth thinking about. One, the stock market typically bottoms before the economy does... and two, the market was showing some early signs of the "animal spirits" awakening.

For one thing, the bond market was showing less "fear" than at the end of 2022... but small caps and growth stocks were still underperforming the market, leading Matt to this conclusion...

In the end, we're optimistic that the markets will trend higher in 2023. But we doubt it will happen right away...

That statement turned out to be spot on.

Matt wasn't exactly referring to a potential bank crisis, like we saw in March, as being the reason that a turn higher for stocks wouldn't happen immediately, but that looks like what has happened thus far.

Bullish sentiment did grow a bit earlier this year. Then, after the Fed's "rescue" of banks in March, more bullish trends took hold, beaten-down growth stocks rallied, and now small caps are showing signs of life.

Whether a "soft landing" is ahead for the economy, or a "hard one" that includes a bad recession and higher unemployment – and likely pain ahead for stock prices – we can't say for sure.

When we look back on this period several years from now, it's possible this entire run higher for stocks in 2023 will be considered one big "bear market rally" that ends when the Fed finally does cut rates.

Though perhaps more than any other scenario, it appears to me as time goes on that an idea is worth considering in either case... that all the stimulus injected into the system amid the pandemic might require years and years to "burn off," if it ever totally does.

Sticky inflation and a higher-for-longer interest-rate environment are the most likely consequences. A recession could still be ahead, but as a lot of people wait for it, stock prices can keep going up – as the animal spirits awaken.

Last call...

Finally, don't forget about our big AI event, which gets going at 8 p.m. Eastern time tonight.

Stansberry Research partner and Retirement Millionaire editor Dr. David "Doc" Eifrig will share the stage with Marc Chaikin, founder of our corporate affiliate Chaikin Analytics, to debate the latest market craze: artificial intelligence.

What's real? What's hype? What are the trends in AI worth watching or investing in today? Doc and Marc – two of the brightest investing minds I've ever come across – will talk it all out, and we're looking forward to this entire free discussion.

From what I've heard about the event, I'm confident viewers will come away at the very least learning something new about AI. You'll also hear a couple of free predictions about three of America's most popular stocks right now. Don't miss it.

Click here to sign up for the event now to make sure you don't miss a minute when it begins in less than two hours.

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In today's mailbag, a subscriber's take on artificial intelligence. Remember, our big AI event begins at 8 p.m. Eastern time tonight... Click here to register now and don't miss it... And as always, send your comments and questions to feedback@stansberryresearch.com.

"AI is the twin sister of robotics. Because both of them will put people out of work. But just like robotics, AI will continue to expand. With or without the consent of the general public. Several decades ago, automobiles were built completely by human hands and some basic machinery. Now robotics have replaced much of that work that was previously done by humans.

"Companies are thirsty for faster, cheaper, and more efficient methods of production of their products and services. Strikes won't stop AI from getting into the entertainment industry or anywhere else. It's how to build a better mouse trap 101, all over again. People are just going to have to get other training for other work opportunities in different fields of emerging economies. It's the law of progress." – Subscriber John M.

All the best,

Corey McLaughlin
Baltimore, Maryland
July 19, 2023