We’ve been talking about weak investor sentiment now dating back to last spring AFTER inflation started rippin’, AFTER the Fed finally awoke from their 2022 winter slumber, AFTER interest rates had surged, and AFTER the equity markets had sold off. SFP = sentiment follows price. Despite recent recovery in risk assets, investor sentiment still remains low. Markets need a wall of worry in which to advance – that wall of worry is weak investor sentiment and is a key underpinning to our optimistic view on risk assets at today’s prices. Warren Buffet says it best: be bullish when no one else is.
Weak investor sentiment is being joined now with “weak investor positioning”. It’s one thing to say you don’t like the market: it’s another to place a bet that it’s going down. Hedge funds are doing that now. Market rallies start to act great when sentiment is weak AND positioning is offsides (too negative). We define “weak positioning” as hedge funds being short SP500 futures, betting that the equity market goes lower. The circled areas in the chart below capture extreme moments of such weak investor positioning. Those moments look like late 2015/early 2016 (AFTER China and energy prices had cratered), the second quarter of 2020 (AFTER COVID19 had arrived and AFTER equity markets had sold off), and the last 3-6 months now (AFTER the market had gone down already because the Fed got way too far behind in early 2022).
Recession risks are very, very high. I believe that is already well-known. Corporate earnings are likely to fall in such a macro environment, also very, very well-known. But investor sentiment is weak and investor positioning already negative as the USD is now falling, interest rates are falling, inflation is cooling, and market technicals are improving. The best opportunities for the near/intermediate term are things that were very unpopular the past few years: value > growth stocks, small cap > large cap tech, non-USA v USA, emerging markets, and China (where a massive wave of COVID is likely to happen post Lunar New Year holiday).
Volatility brings about opportunities.
Richard Barrett
Chief Investment Officer
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