Is sentiment souring?

By David Morrison  |  16/11/2018 15:36

We’re heading into a holiday-shortened week when trading volumes should decline. However, that doesn’t mean we'll see a pull-back in volatility

Sometimes it takes a long time for investors to shift from bullish to bearish, or bearish to bullish. In the latter stages of a bull market investors slowly turn from interpreting all news and economic data releases as in some way market-positive, to viewing everything as market-negative. For example, over the last few years we’ve seen better-than-expected Non-Farm Payrolls taken as evidence of US economic strength and therefore an excuse to load up on equities. Yet maybe a month later, a poor reading is interpreted as a reason for the US Federal Reserve to hold off from raising rates. Bingo! Another reason to buy stocks. It doesn’t matter what problems emerge. The shock Brexit vote and unexpected Trump victory back in 2016 saw risk assets sell off initially. But within days (or hours in the case of Trump) investors were soon jumping back in and taking advantage of dips to increase their exposure to risky assets. This is typical of a bull market which has continued even as the US stock market is considered overvalued by many measures and even as the Fed ended quantitative easing (November 2014) and had started to tighten monetary policy (December 2015).

Sentiment turns

But gradually sentiment starts to turn and market reversals chip away at investor confidence. It took six months for the S&P 500 to hit a fresh record high following the corrective pull-back that we saw at the beginning of the year. Then, having hit a new high, just one month later, stocks dumped again. Earlier this month US equities bounced back sharply following the October sell-off. However, the S&P 500 remains below its 200-day moving average (which comes in around 2,760) and the bulls won’t be back in the driving seat until they force a few closes above this area. Until then, the index continues to pivot around 2,700 which means the October low just above 2,600 remains a possible downside target.

Still bullish?

Earlier this year there was a lot of chatter (from me as well) about the likelihood of an inverted yield curve and whether that signalled an impending recession or not. That’s no longer a topic as the curve has steepened again. Now some analysts are weighing up the likelihood of another stock market crash. All kinds of triggers are being mentioned: a US/China trade war, Brexit, an Italian bond market rout, a stronger dollar leading to emerging market chaos, a blow-up in the huge overleveraged corporate bond market. Anything could trigger a crash, but predicting one is a different matter. Anyway, a bear market shouldn’t always be conflated with a market crash, although a market crash often precedes a bear market. Nevertheless, equities can trade sideways or trend downwards for long periods of time, frustrating investors looking for capital gains on top of dividends. When this happens, investors cast around for other assets which have the potential to provide a better, or safer, return. It’s possible that we’re entering that kind of environment now.

Sell-off reversed

Last night saw a sharp reversal on Wall Street where early weakness gave way to a strong rally. The move saw all the majors close higher with the Dow piling on over 200 points and gains of more than 1% for the S&P 500, Nasdaq and Russell 2000. JP Morgan was in the vanguard of the move higher in banking stocks which had fallen sharply after Maxine Waters (soon to take over the House Financial Services committee) said that there would be no further weakening of banking regulations. Apple led a recovery in tech.

The week ahead

We’re going into a holiday-shortened week with US markets closed on Thursday for Thanksgiving. This means that trading volumes will be lighter than usual, but that can often lead to a pick-up in volatility. Tuesday sees the release of minutes from the Reserve Bank of Australia’s last monetary policy meeting, the Bank of England’s Inflation Report Hearings and another OPEC-JMMC meeting, which is bound to affect the oil price. Later in the day we have US Building Permits and Housing Starts. On Wednesday we have US Durable Goods, Consumer Sentiment, Inflation Expectations and Crude Oil Inventories. Thursday brings the release of the ECB Monetary Policy Meeting accounts and it’s US Thanksgiving. Japanese markets are closed on Friday. Later that day we have Flash Manufacturing and Services PMIs from across the Euro zone together with Canadian CPI and Retail Sales.



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