Markets seem to be “climbing a wall of worry,” which is healthy. Bubbles happen when enthusiasm is unwatched and the market climbs unchecked; it would be hard to argue that it is happening now.
“Davidson” submits:
Market prices of every sort are driven by market psychology in anticipation of events that investors believe will prove profitable, all market prices bar none i.e., commodities, equities, debt securities and their derivatives etc. They are priced today by consensus for an expected shift to future prices with some bets for higher prices and some lower. Whatever the current price is, it is a balance of expectations and the consensus view. Often short-term oriented, most investors do not step-back and truly think through that market prices do not carry much in the way of future economic guidance. Instead, they trade as if a sudden shift in price means a sudden shift in economics. A shift in sentiment, yes, but not economics.
Economic trends always shift at snail’s pace. The two exceptions in the last 70yrs were the COVID lockdown and Paul Volker’s early 1980’s rate hikes. Other than those, economic trends plod along slowly with many revisions monthly such that the best one can do is to track the trailing 12mo economic trend. Being short-term, many react to every monthly report as if it offers new guidance when next month’s report is typically revised making last month’s spot decisions irrelevant.
The charts below show 5 sentiment indicators, SP500 Net Non-Commercial Futures, $WTI(West Texas Intermediate oil price), SP500, 10yr minus 3mo Treasury rate(traditional Yield Curve) and 30yr minus 2yr Treasury rate(newly defined Yield Curve). Of the 5 shown, 3 reflect negative sentiment and recession fear while the 30yr minus 2yr Treasury rate improves to a positive 37bps reflecting the belief in economic expansion. The correction in the SP500 reflects a backing away of the recession bet for Mag 7 i.e., Mag 7 less favored with economic growth.
The last 24mos or so investors have wrung their hands over a pending recession, The main factors have been a manufacturing PMI below 50 and inverted Yield Curves (both being manipulated for recession strategies by different sets of investors-IMO). The consensus has made it clear that shorting near-term Treasuries and buying longer-term Treasuries were strategies employed. By entering these strategies, investors forced each Yield Curve indicator deeply into negative territory making these no longer reliable recession indicators. At the same time, some have embraced the tech-issues as a recession safe-haven, especially those tied to the current AI(Artificial Intelligence) craze, as winning investments during recession. The net/net is they have concentrated capital into these issues such that seven, the Mag 7, comprise 25% or so of the entire value of the SP500 and responsible for its new highs the last 24mos or so. Thus, when the 30yr minus 2yr Treasury rate popped into positive territory and signaled economic growth, the Mag 7 were no longer the sole equity strategy.
What we see today is the SP500 correcting (a positive shift in market psychology) due to the correction of the Mag 7issues as the 30yr minus 2yr Treasury rate moves further positive. Meanwhile, the other Yield Curve, the 10yr minus 3month Treasury rate, remains deeply negative near -1.42 and $WTI plunged to $68BBL on recession fear as SP500 Net Non-Commercial Futures is holding in negative territory at -48.80. Sentiment is messy. Different investors deploy different strategies, and we can see this playing out in the differences of these sentiment indicators.
When taken as a whole, sentiment is improving. Last week, the manufacturing PMI remained below 50 while IndProd remained high and stable indicating stable economic growth. Some sentiment is beginning to recognize that there is economic growth ahead now and not recession. It has taken a long time to achieve this shift from SP500 Net Non-Commercial Futures at -434.20 in Jun 2023. As this pessimism continues to lift, I expect to see further correction in the Mag 7 accompanied by improvements in those issues unfairly ignored.
To sum, sentiment is improving slowly. I expect this to continue with discounted industrial and oil/gas issues to regain prior valuations relative to their financial performances.
