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Has Investor Sentiment Turned a Corner in 2023?

Published 02/13/2023, 07:06 AM
Updated 07/09/2023, 06:31 AM
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  • Bullish sentiment is on the rise as bearish sentiment falls to multi-decade lows
  • Global recession may not be as deep and as long as feared a few weeks ago
  • And once again, the stock market has proven itself to be the best long-term investment
  • After a very positive start to the year for global equity markets, the question on the back of everybody's minds is: Are we seeing a major shift in investor sentiment?

    It certainly seems that way. Optimism is back, but not because of what we have just seen in AAII sentiment. It turns out that investors have unwound $300 billion of bearish positions, and retail investors have also returned to buying after a year of sluggish activity.

    Retail investor orders in stocks and ETFs accounted for 23% of total market volume at the end of January, up from the previous high of 22% during the 2021 meme stock craze.

    We all know the importance of the 200-day moving average in the markets, it is a good indicator of strength or weakness.

    S&P 500 Daily Chart

    In the case of the S&P 500, it overcame the 200-day MA at the end of January after a pullback. It rose from 4012 to 4195. But the fact that the index is overbought is causing these recent falls, just like last August.

    I would like to leave you with one interesting fact. It turns out that the average return on days when the S&P 500 is above its 200-day moving average is +0.09%, which means an average annual return of +25%, taking into account 260 trading days per year.

    Conversely, when the S&P 500 is below its 200-day moving average, the average return for those days is -0.11%.

    Of course, past performance is no guarantee of future performance, but as Mark Twain said, it often rhymes.

    Since the end of World War II, there have only been two occasions (1967 and 1975) when the S&P 500 rose +5% in January after falling -10% or more in the previous year. This shows how interesting January has been in the current context.

    Although 2022 has been a tough year for equities in general and US equities in particular, this should not prevent us from being optimistic for 2023. Since 1928, the S&P 500 has delivered an average annual return of +9.7%.

    In other words, the stock market is the best long-term investment, as history shows. $1 invested in equities in 1802 would have been worth $705,000 in 2012. On the other hand, the same dollar invested in bonds would be worth $1,780, and if it had been invested in gold, it would be worth $4.52.

    Investor Sentiment (AAII)

    Bullish sentiment, defined as expectations that stock prices will rise over the next six months, increased by 7.6 percentage points to 37.5%. This is the highest level of optimism since 30 December 2002 (37.7%).

    It is also the first time in 58 weeks that bullish sentiment has reached its historical average of 37.5%. Bearish sentiment, defined as expectations that stock prices will fall in the next six months, fell by 9.6 points to 25%. This is the lowest level of pessimism since 11 November 2002 (24%). It is also below the historical average of 31%.

    Market’s Reaction to the Economic Slowdown

    The global recession may not be as deep and prolonged as feared a few weeks ago, as China's economy rebounds rapidly and inflation cools in the US. Indeed, the International Monetary Fund has raised its global growth forecast for 2023.

    There are a number of facts that should ease concerns:

    • The risk premium on junk bonds is at its lowest level since the second quarter of last year.
    • US job growth rose in January, and the unemployment rate hit its lowest level in more than 53 years.
    • Copper is up +8.1% so far this year. Copper is seen as an early barometer of the economy's health, so much so that it is nicknamed "Dr. Copper" on Wall Street.
    • It is true that there are very strong companies that are laying off workers. But it is also true that many of them are in the technology sector. During the coronavirus pandemic, these companies hired massively. So these companies do not reflect the economic reality.

    But how does the S&P 500 react to economic downturns? Well, for example, over the last 72 years, when there have been recessions, the S&P 500 has fallen by an average of -2.1%. There have been some recession years where the decline has been greater than -30%, such as in 2007 and 2020.

    And what are the signs that there will be a recession? Let me list 4 elements:

    1. Inverted yield curve: this occurs when the yield on short-term bonds is higher than the yield on longer-term bonds. It usually takes 1-2 years from the warning of a recession until it is officially confirmed.
    2. Residential building permits: reflect the number of permits issued by the government for new construction projects and are a leading indicator of the state of the housing market.
    3. The Economic Trend Index (ETI): tracks the movement of 14 indicators that give a good picture of the economy. If it is above 50, it is good, but if it is below 50, it indicates the beginning of a recession.
    4. The SKEW index: the higher it rises, the greater the expectation of recession. Values vary between 100 and 150 points. Ideally, it should be around 100 points. Its usual range, when all is well, is between 100 and 120 points.

    Global Stock Market Rankings

    It was a week in the red for the main stock markets. The performance of the main European and US stock exchanges so far in 2023 is as follows:

    Disclosure: The author does not own any of the securities mentioned.

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