Key Takeaway: Put/call ratios are high, there are more bulls than bears on both the AAII and II surveys (a rarity over the past decade) and active investment managers have slashed equity exposure. If the conditions that have been in place since the Financial Crisis lows (which occurred this week in 2009) are still in place, it is hard to argue that sentiment is not a meaningful tailwind for equities and is fuel for a rally. Two cautions: Sentiment is a condition, but rarely a catalyst. This means price action needs to improve to bring bulls back on board. But more significantly, there is still evidence that the speculative unwind that began last year is still ongoing and strategic positioning indicators show little improvement that would indicate longer-term risks are subsiding. Those get exacerbated as the Fed starts to raise interest rates and withdraw liquidity.
Sentiment Report Chart of the Week: Liquidity-Fueled Speculation Now Unwinding
Fed rate cuts in 2019 primed the pump for a surge in speculative activity and the flood of liquidity that was provided in response to COVID was fuel for the fire. While investors and advisors are turning pessimistic, there is evidence that the unwind in speculative activity is still ongoing. Equity call options and NASDAQ trading volume peaked a year ago but are still well above levels from just a couple of years ago. The Fed made its final QE purchases today and is poised to raise rates next week. With liquidity tightening, I expect further unwind in speculative activity going forward.
