Shifting Sentiment Caused Swoon in Stocks


Financial markets can be faddish. At times, they seem quite content wallowing in the countless puts and takes aroused by rumor and feeling. Other times, it’s the sturdiness of their fundamentals that justify the next big move up or down.

Investors do themselves a radical disservice when their action appeals away from fundamentals, when it says what matters is not why something is driving the market but what it means for me. Shun sentiment for fundamentals or fashion for sensibility all the while we may have sawn the branch we looked forward to sitting on.

Up through late spring, the scaffolding bracing the market was sentiment as underlying fundamentals where not actually changing and, if they were, it was only at the margin. Throughout the winter and spring of 2015, U.S. economic data was good enough, Europe was no worse than feared, and China was still growing but, admittedly from a very high base. That kept domestic equity markets whipsawing around the flat line for the last seven months. Even with the many unknowns of the first-half of 2015 (Fed liftoff, OPEC, Iran, Europe, Greece, strong dollar) none of it was strong enough to move fundamentals to the point where sentiment would change. Nor was any of it sufficient to push sentiment off the porch in search of more convincing fundamentals.

The evolution or change in investor perception brings to mind strong parallels of the way we view artwork. Up through the end of May, market sentimentality possessed the appealing and evocative draw of a silhouette.  One where the observer desired space for imagination and interpretation, while quickly losing interest if the artist had left no room for it.

For months investors peered at misleading pseudo-pictures including the breathless commentary about high equity valuations, warnings of social-media stock bubbles, the potential disruption of inflation, disinflation, and monetary policy.

By the end of spring, investor sentiment was solidified and appeared to possess the proper, indeed reverent, carefulness of a surgeon rather than the blundering haste of the established yet narrow world of technician’s charts, academician’s white papers, and textual variants. Sentiment was certainly cautious and at times extremely gloomy, but investors couldn’t dismiss the European continent and its stock market producing 14% year-to-date returns. Peering through a silhouette in search of a portrait in and of itself produced an overwhelmingly complacent environment where a continued bull market was simply inevitable.

Now it gets super-ugly and highly-complicated as the S&P500 has shed 6% from its July 20 apex, trading well below its major moving averages and presently sitting down near 2.5% year-to-date. It’s highly complicated because this latest expression of super negativity pales in comparison to the recent and persistent over-sized moves in foreign exchange, commodities, and credit.

Using other asset classes as a guide would suggest that the major stock averages should be down at least 10% by now. For all the recent ugliness, stocks are actually relatively resilient – whether you peer through a fundamental or sentimental lens.

From here, whether our markets are resetting to a new set of fundamentals or a simple change of heart is anyone’s guess. Personally, I believe we are in the middle of a gradual recovery and that advanced economies can and will weather what I’ve always called for – a painstakingly prolonged period of fundamentals leading sentiment and others where sentiment leads fundamentals. Today, we are all way too negative!