Sentiment indicators are a way of quantifying investor positioning within broad asset classes with hopes of predicting the group’s future behavior. Some investors look at sentiment indicators as contrarian signals: as price becomes overextended, the probabilities increase for a reversion back to the mean. For example, rising stock prices attract buyers (Euphoria), and falling stock prices attract sellers (Panic). If too many investors are leaning too far in one direction, we could see prices adjust against the current trend.
Risk-on asset classes are in strong demand right now, with small-cap stocks, emerging market stocks, strong home sales, and economic sensitive commodities (oil and copper) leading the charge higher. Risk-off asset classes (health care, utilities, real estate, and consumer staples) are lagging for the last six months, which also confirms the bullish outlook. With the Federal Reserve setting short-term interest rates near 0% and lawmakers passing multi-trillion dollars of stimulus (and potential of more to come), investors have been rewarded by looking past economic concerns facing the US and global economies. Further adding fuel to the fire, Treasury Secretary Janet Yellen pledged her support of additional stimulus and even said “go big” regarding future government intervention. Is the current market environment the latest round of irrational exuberance, or do fundamentals justify the current valuations?
The Citigroup Panic/Euphoria Index attempts to measure sentiment by tracking metrics from outstanding margin debt, option trading, and newsletter bullishness. This is just one sentiment reading and does not necessarily mean the bullish advance is over. Investors must be cautious with sentiment indicators because one can easily become susceptible to Confirmation Bias, which is looking for information that confirms existing beliefs and ignoring or undervaluing information that contradicts these beliefs.
JANUARY 1987 – JANUARY 2021
After listening to many economic outlook forecasts, reading economic reports from top economists, and researching market activity, one can find common themes:
- Many industry experts are looking for the US Dollar to continue to decline and interest rates to remain low.
- International stocks to outperform domestic stocks.
- Rising inflation to lift commodity prices.
But what if these outlooks fail to materialize? Could we see a reversion to the mean that catches investors off-guard? Sure, anything is possible. The human decision-making process still dictates the investment process, which opens the door to emotional behavior – both Euphoria and Panic. The Wall Street adage that fear and greed drive the markets; however, at market highs, the fear of missing out can be a driving factor to advance the markets. No one knows what will come next month or next week or even tomorrow. News flow will intensify and could become a catalyst for the markets as investors will be focusing on corporate earnings reports, economic data, inflation rising faster than the Fed’s 2% projection, additional stimulus, and President Biden’s policy changes. We do our best to stay objective, follow our process, and balance the risk-reward of each investment opportunity made in your portfolio with the information we have at a given time.
Keep an eye out for the recording of our Annual Forecast Presentation next week as we dig deeper into the topics above!