Have ‘Animal Spirits’ Taken QE’s Place As The New Fuel For The Bulls?

February 5, 2017

Weekly Market Outlook

By Geoff Bysshe

ouloook-20170203-thumb-244President Trump has summoned up ‘animal spirits’ which seem to be taking more and more credit (or blame depending on your market bias), for the bull market.

Here’s one way to keep your eye on them, so they don’t catch you by surprise.

Additionally, this week’s video (below) will show you ways to let the market, not animal spirits drive you to the best trading opportunities.

Over the last several weeks I’ve noticed more and more analysts justifying the continuation of the bull market with a term that has not been used for quite some time, “animal spirits”.

So what are “animal spirits”, and how do they affect the market and the economy?

The term was coined in 1936 by the famous economist John Maynard Keynes, to describe the psychological forces that partly explain why the economy does not behave as predicted by classical economic theory. It’s important to note that classical economic theory was grounded in the belief that “economic decision makers” (people) would make rational decisions.

In other words “animal spirits” is how one of the fathers of modern economic theory described the fact that economic decisions are often based on emotions, intuition, and irrational behavior.

I’m sure such a conclusion doesn’t come as a surprise to most of you reading this post, but be sure to keep that definition in mind when you hear an analyst, economist, or commentator use ‘animal spirits’ as his rational explanation for why the economy and or market will continue to trend higher.

To be fair, animal spirits, could be considered just a fancy term for “optimism” which is more easily recognized as valid reason to expect economic growth and rising stock prices.
And as it turns out, there is a very real measure of consumer optimism. It can be found inside the University of Michigan’s monthly Consumer Sentiment report.

Below you’ll see a chart of the monthly Consumer Confidence data in which you’ll see a rather steady up trending purple line that represent the level of confidence that survey respondents have in current economic conditions.

However, the more interesting data in this chart is the yellow line which represents consumer “expectations”. More specifically, this line reflects survey respondents’ expectations looking out 6 months for business conditions, employment and total family income.


In order to make this picture clearer, I’ve provided another chart that only shows this same measure of Consumer Expectations below along with a chart of the SPY (S&P 500 Index ETF). In the Expectations chart, the dotted line is monthly data points, and the solid blue line is a 3-month average.


What is clear in the data is that since the election there has been a big jump in positive expectations or optimism.

From late 2008 to late 2014 stocks benefited from the Fed’s Quantitative Easing policy, but even with that as a tailwind you can see how major shifts in expectations have coincided with significant market moves: turn up in 2009, down in 2011, up in 2014, down in 2015, and now up in 2016.

Given this pop in Consumer Expectation data, I think the animal spirits are, in fact, back, and investors may become more likely to base their decisions on emotions, intuitions, or even some irrational ideas!

And without QE to blame for the bull market, you’ll probably be hearing more about animal spirits.

However, before you interpret this a rational reason to expect a market top, consider the words of another famous student of animal spirits, and master of the markets, Sir John Templeton...

“Bull markets are born on pessimism, grown on skepticism, mature on optimism and die on euphoria”

Personally, I don’t think the animal spirit are euphoric yet.

Check out this week’s video below and let the market, not animal spirits drive you to the best trading opportunities.

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