‘Dumb Money’ FOMO Could Trap the Dow Jones in a Downward Spiral

May 11, 2020 7:46 PM UTC
U.S. consumers continue to express record optimism about the stock market, which could mean the Dow's "FOMO rally" is coming to an end.
  • There’s a wide divergence between how consumers feel about the economy and the stock market.
  • As Americans grow more fearful about the economy, they’re expressing even more confidence in the stock market.
  • Does this mean the “FOMO rally” that fueled the Dow Jones recovery is about to come to an end?

The stock market is not the economy, but that doesn’t make it any less unsettling that the gap between how Americans feel about them is growing wider by the month.

And as the Dow Jones struggles for direction following a feverish recovery, analysts warn that FOMO could set investors up for a painful downturn when the mood finally sours.

Consumer Sentiment Continues to Darken

The coronavirus pandemic has given new meaning to the phrase “ugly economic data,” but the latest statistics from the Federal Reserve Bank of New York’s Survey of Consumer Expectations reveal just how down on the economy everyday Americans have become.

Key measures of consumer sentiment plunged across the board in March, only to careen ever lower in April. Many are now plumbing lows not seen since the Fed introduced this survey in 2013.

Respondents believe there’s a mean probability of 21% that they’ll lose their job within the next twelve months. Barely a quarter believe they’ll be in a better financial situation one year from now – down from about 43% in January and February.

And the median expectation for income growth this year fell to 1.87% – the first time this indicator has ever come in below 2%.

April was the first time the median expectation for household income growth fell below 2%. | Source: New York Fed

Suffice to say that consumers are not bullish about the economy or the security of their place in it. And yet there’s one segment of the financial landscape that they’ve never been more confident about.

But They’ve Never Been More Bullish on the Stock Market

It’s not the expectation that the unemployment rate will go up this year. Nor is it their household’s risk of falling into delinquency on at least one debt payment in the next three months, although both of these metrics are flirting with all-time highs.

It’s the belief that the stock market will be higher one year from now than it is today.

Consumers have never been this bullish about the stock market, at least since the Fed began this monthly survey in 2013. | Source: New York Fed

Consumers predict there’s a 51.8% probability that stock prices will increase over the next year. It’s the second straight month this indicator has reached a new zenith.

Before March 2020 – when the Dow Jones Industrial Average was trapped in a devastating tailspin – this measure of stock market sentiment had never exceeded 45.44%.

That’s a dangerous sign for the stock market, especially considering that Goldman Sachs was already warning that “fear of missing out” (FOMO) had caused the Dow’s breathtaking recovery to exceed its underlying fundamentals.

Goldman Sachs Warns the Dow’s ‘FOMO’ Rally Could Be Over

The Dow and S&P 500 have rallied around 30% off their late-March lows. | Source: Yahoo Finance

David Kostin, the investment bank’s chief U.S. equity strategist, wrote in a new report that investors are downplaying a bevy of economic headwinds.

And to make matters worse, they’re doing it with stock valuations already at their most inflated levels since 2002, with the S&P 500 trading at 19.5 times earnings estimates.

“A single catalyst may not spark a pullback, but a number of concerns and risks exist that we believe, and our client discussions confirm, investors are downplaying,” Kostin wrote. “The ‘fear of missing out’ best describes the thought process.”

Although the relatively high number of S&P 500 shorts potentially loads the market with dry powder to ignite the next upward lunge, Goldman warns that there’s equally-bearish evidence that an abnormally large number of investors haven’t taken profits following the recent recovery.

This not only suggests that investors have succumbed to FOMO but also creates a looming downside risk. Because if sentiment begins to darken, or the Dow hits a ceiling and begins to bleed lower, those same investors could rush to take profits before they disappear altogether.

What if the ‘Dumb Money’ Knows What It’s Doing?

Retail investors – often derisively called the “dumb money” – don’t have a great track record when it comes to playing the stock market.

Only this time around, aside from a few cringeworthy attempts at capitalizing on the oil price crash,  the “dumb money” played the market perfectly. Up until now, anyway.

Retail Interest in the Stock Market Tapers – But Remains Elevated

On the one hand, “dumb money” interest in the stock market has fallen considerably since the stock market rocketed off its lows. Google searches for “Dow Jones,” “stock market,” and “buy stocks” have all declined by nearly two-thirds from their mid-March peaks.

Google interest in “stock market” (blue) and “buy stocks” (red) has plunged from March’s record levels, but these searches continue to attract greater-than-usual volume. | Source: Google Trends

On the other, search volume for all three of these terms remains at least double their “normal” interest.

This is all the more remarkable considering that the unemployment rate spiked to Great Depression levels in April, leaving more than 20 million Americans with no income to “buy stocks” and more important considerations than the Dow’s day-to-day fluctuations.

This suggests there’s still plenty of air to let out of the stock market’s balloon. At least in the short-term.

Stocks Could Dive 20%, Then Recover Swiftly (Again)

Goldman Sachs and David Kostin expect the S&P 500 to dive as low as 2,400 within the next three months, a slide of nearly 20% from its current level.

Goldman Sachs believes the S&P 500 could crash as low as 2,400 before recovering to just above its current level. | Source: Yahoo Finance

But the strategist doesn’t expect it to stay there for long. In fact, he expects the index to surge back to 3,000 by December.

Given that the S&P 500 opened slightly above 2,900 on Monday, this forecast implies the stock market will enter the new year marginally higher than it is today. Just like the Fed’s consumer expectations survey predicts.

Maybe, for once, “dumb money” actually knows what it’s doing.

Disclaimer: The opinions in this article do not represent investment or trading advice from CCN.com. The author owns shares in S&P 500 index funds.

Sam Bourgi edited this article for CCN.com. If you see a breach of our Code of Ethics or find a factual, spelling, or grammar error, please contact us.

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Josiah is the U.S. Editor at CCN.com, where he focuses on financial markets. His work has also been featured on Yahoo Finance and Investing.com. He lives in rural Virginia. Connect with him on LinkedIn or Muck Rack. Email him directly at josiah.wilmoth(at)ccn.com. Josiah Wilmoth is a Trusted Journalist.