Key Takeaway: Optimism wanes, and pessimism builds as the II bull-bear spread narrowed last week to just 1.2%, down more than 4% from the previous week. That brings the spread to its smallest difference since early April 2020. But it’s not until bears outnumber the bulls that we reach levels associated with significant market bottoms. Nevertheless, a surge in pessimism could become reality with active equity managers continuing to reduce exposure, consensus bulls dropping, and major equity indexes testing their respective January lows. Whether sentiment has completely unwound or is still in the process of unwinding is yet to be determined.
Sentiment Report Chart of the Week: Unwound or Unwinding
Key Takeaway: Speculative excesses have been unwinding for a year and that has taken its toll on investor sentiment. The overall mood is characterized by a lack of optimism rather than rampant pessimism. This is consistent with the grind lower in many areas of the market since new highs peaked in February 2021. The damage done beneath the surface has only in recent months impacted the indexes, but if that impact intensifies a further expansion in pessimism would not be surprising. Benchmark 60/40 portfolios have gotten off to their worst start in a quarter century and our strategic positioning indicators continue to point to a high risk backdrop. If there isn’t much of a reward at the end of the volatility rollercoaster, passive participants may start to actively question whether the ride was worth it.
Key Takeaway: Sentiment has unwound to a point that it’s now seen as an opportunity rather than a risk. Pessimism runs high, investors are cranky, and we have had the most bears since 2016. On top of that, our universe of risk-on/risk-off ratios continues to lean toward the risk-off side of the scale. There are signs of budding pessimism (Consensus bulls have risen for the second week in a row and the NAAIM exposure index fails to register excessive pessimism) after the recent bounce in the major equity indexes. But without a strong enough reaction to produce meaningful breadth thrusts it’s difficult to be bullish on the broader market.
Sentiment Report Chart of the Week: Sentiment Composite Points To Opportunity
Key Takeaway: Investor sentiment looks washed out - at least for now. Investor sentiment was a headwind early in 2021 but more recently had been a neutral market influence from our weight of the evidence perspective. Now, with the indicators pointing toward fear and pessimism and equity inflows sputtering to start 2022, it looks like sentiment now is a tailwind for equities. How long that persists remains to be seen. Seeing pessimism and fear remaining elevated even as if stocks stop going down could help sow the seeds for an unloved rally. Longer-term, there remain imbalances from a valuation and asset allocation perspective that remain unresolved.
Key Takeaway: US stocks are on the ropes after taking a series of heavy hits in recent weeks. This comes against a backdrop of rising volatility and fear, fueling an increase in pessimism. A complete unwind from speculative extremes is underway as a market that once bent under pressure is now beginning to snap. The silver lining is that there are still pockets of strength among cyclical/value sectors, like energy. The question is whether or not this can remain the case in the face of widespread pessimism.
Sentiment Report Chart of the Week: Leadership Rotation Gets Energetic
Key Takeaway: A sentiment unwind can be constructive if it bends but doesn't break. That is, if volatility squeezes out some excessive optimism without ushering in pessimism. On the other hand, when it breaks it becomes like water through a dam, creating a messy and, at times, chaotic environment. So far the unwind from the speculative extremes of early 2021 has been orderly and has not broken through. But pressure is building and the dam must hold if we want to still talk about rotational churning and not move on to discussing sustained cyclical weakness. That's the challenge for 2022.
Key Takeaway: Investor sentiment surveys are showing waning optimism as 2022 gets underway but there is still little evidence of fear. From a flow and positioning perspective, the 2021 excesses have not been unwound. Equity ETFs continue to record huge inflows even as households have near-record exposure to equities and stocks trade at never before seen valuations. The resolution to these imbalances could come more from rotation than from an outright unwinding. While risk appetite in the US is fading (particularly for the speculative names that were surging higher at this time last year), currency markets suggest renewed interest in global assets. Overseas equities and commodities are gaining strength. They could provide a needed alternative if investors really start to sour on US equities.
Key Takeaway: Year-end strength in stocks alleviated some of the concern that had crept into investors’ collective psyche. Short-term sentiment swings aside, investors remained positioned aggressively long stocks at a time when strategic risks remain high. December set a monthly record for equity ETF inflows and that price chasing pushed equity valuations to some of their highest levels on record. The optimism in positioning is not reflected in the sentiment surveys. But if the unwinding in the speculative bubble that peaked early last year gains steam, look for a lack of optimism to be replaced with outright pessimism, followed by a re-positioning of assets.
Sentiment Report Chart of the Week: Commodities soar but struggle for attention
Key Takeaway: The sentiment backdrop is more characterized by a lack of optimism than widespread pessimism. This is in sharp contrast to the experiences of December 2020 and 2019. In those instances, too much holiday cheer led to hangovers in the year that followed (don’t forget, new highs peaked early in 2021 and many areas have been a sideways mess for months now). The current sentiment backdrop is not dissimilar to (though less extreme than) what was experienced in December 2018. Intense selling that month had investors thinking more about the Grinch than Santa Claus. While probably won’t get widespread pessimism this time around without further volatility - but if we do and investors throw in the towel on stocks, it could ultimately help light a fire that leads to early year breadth thrusts like what we experienced in early 2019.
Key Takeaway: We have seen some evidence of fear on a shorter-term basis, but still plenty of optimism (and risk) from a longer-term positioning perspective. If we had to sum up the current sentiment backdrop with one data point it would be the AAII survey that shows even split between bears and bulls. Sentiment is neither here nor there and that leaves the door open to a more complete unwinding in optimism at a time of year when the market tends to be filled with holiday cheer. Combine that with increasing headwinds from deteriorating breadth and the trend in earnings revisions turning lower, and the sentiment shifts of 2021 look increasingly incomplete as we move toward 2022.
Sentiment Report Chart of the Week: Earnings Estimates Rolling Over
Key Takeaway: Volatility is on the rise and the bulls are in retreat. The recent downside pressure on risk assets has driven investors to take caution. Yet, pessimism remains subdued as volatility was unable to stoke real fear. Now that the market is beginning to rebound, the bullish case needs to prove it deserves the benefit of the doubt. Price needs to justify the risk appetite that still lingers and participation needs to expand. On the flip side, another spike in volatility could woo the bears out of their seats and onto the dance floor. The market finds itself at a critical juncture heading toward year end. The action that unfolds in the coming weeks could well shape investors' approach to risk in 2022.
Sentiment Report Chart of the Week: Despite Some Caution, Investors Still Love Risk
Key Takeaway: The bulls came out expecting strength but were served a healthy dose of volatility. What on paper is a historically favorable season has turned out to be quite the opposite. New highs quickly fell to the wayside and into the rearview mirror as participation crumbled beneath the surface. In the wake, investor optimism is now accompanied by a sobering caution. The need for repair beneath the surfaces is great for both domestic and international equities, and is necessary to re-build investor confidence. For now, there are no significant signs of pessimism emerging. But volatility and pessimism can be dangerous dancing partners, each leading the other to the edge of the dance floor.
Sentiment Report Chart of the Week: Investors’ Love Of Equities Undiminished
