(Bloomberg Opinion) – Feelings
For some reason, people are feeling good. Animal spirits are on the run. For one dramatic illustration, if we use the popular (but wildly over-simplistic) definition that any 20% gain is a “bull market,” the NYSE Fang+ index is back in a bull market. The index includes the big hegemonic internet platform companies and has been creamed since peaking late last year, but it has now made up that much room since hitting bottom in May:
On an intra-day basis, the Nasdaq Composite index has also registered a 20% gain from its low, which came in June. Bear markets regularly include deceptive rallies, but this is a forceful advance.
Meanwhile, as tech stocks have surged, bonds continued to show exceptional volatility. During the course of Wednesday’s trading, the benchmark 10-year Treasury yield rose from 2.7% to 2.84% and dropped all the way back again by the end of the day:
The dramatic rise in yields from Tuesday’s trading remained intact, but this takes a lot of explaining. It’s driven by sentiment more than anything else, but how to explain that sentiment? This summary, offered by George Goncalves, head of US macro strategy at MUFG, to my colleagues Ben Purvis and Mike MacKenzie, is plausible:
“Yields rose to levels that looked attractive and the buyers started with the back end and it feels like cash was being put to work in fixed income. There is no sense of a catalyst, but the fact the market can’t hold higher rates suggests there is some skepticism among investors that the Fed will not really deliver on its tough talk.”
Where do such sentiments come from? There are many ways to measure this, but straight counts of stories on the Bloomberg terminal (it tallies all the stories available, not just the ones by Bloomberg News) suggests that worries about inflation have begun to recede, just a little:
This chart uses a rolling 20-day sum, because otherwise the spikes on the days that CPI data come out make it difficult to read. But if people are getting a little a less worried about inflation, a Bloomberg story count suggests that fears of recession have just surged to an almost irrational degree. The recent peak owes something to the publication of second quarter gross domestic product data, but the trend is still clear; there are more stories about recession now than there were at the height of the Covid lockdown in March 2020:
Put these together and you have a partial explanation. Falling bond yields are what we would expect if people are more relaxed about inflation and more concerned about a recession. And falling bond yields, in their own right, are good for stock valuations — and particularly, in recent years, for “long duration” companies whose worth is tied up far into the future. Hence, the rebound for the FANGs makes some sense.
Now we come to the problem. The Federal Reserve has made it abundantly clear this week that it doesn’t want anyone to think that it will be relenting on hiking rates any time soon. Behavior in both stock and bond markets is therefore fighting the Fed, which the oldest trading cliche in the book tells traders they must never do.
There’s also a collective action problem. The Fed can raise the rates that it directly controls; but it also needs broader financial conditions to tighten. If the bond market does not oblige, then the chances rise that the Fed has to push harder, risking a financial accident in the process. The contrast with the last time it tried to change market rate expectations this dramatically is instructive. The 2013 “Taper Tantrum,” when the Fed under Ben Bernanke started to try to ease the market off infinite doses of quantitative-easing asset purchases, was startlingly similar to the way the bond market behaved this year. Here is how the 10-year real yield (a measure that truly captures whether financial conditions are tight) moved from the beginning of 2013 and from the beginning of 2022:
At this point in proceedings in 2013, real yields were leveling off. That was in part because the Bernanke Fed didn’t want them to rise too far, and even postponed the start of its tapering from September to December to help the market calm down. This time around, the Fed isn’t so squeamish and wants real yields to keep rising. Unlike in 2013, it’s already hiked rates several times and is actively shrinking its balance sheet. The fact that traders came within a couple of basis points of taking the real yield negative at the end of last week, then, is bizarre. Even during the tantrum, there was no big market rethink and turn of direction like this. So the bond market seems extravagantly confident that it can fight the Fed, and is behaving very differently from the last time the central bank administered such a shock.
Then there’s the issue of stock traders’ psychology. Lower bond yields, viewed in isolation, are good for stocks. The recession that prompts them, however, is likely to be really bad for share prices. How can stocks possibly be back in a bull market (even if via a dodgy definition) when sentiment has turned so negative about the economy?
That suggests an alternative explanation: It’s traders who’ve lost their heads. And that’s what at least one sentiment indicator is saying. “Dumb Money Confidence,” a creation of SentimenTrader, is an aggregate of indicators that follow “dumb money” trades in the opening minutes of a session. It’s distinct from the “smart money” that waits until stocks have priced in the day’s news and places trades in the closing minutes. SentimenTrader has been computing the measure since 1998, and it works as a rough index of trend-followers’ exposure to stocks.Dumb money traders are traditionally heavily long near market peaks and short near market troughs. Thus, it’s concerning that the indicator has climbed above 60% for the first time in months after a historic stretch of deep pessimism, as this tends to be a critical threshold. According to SentimenTrader’s Chief Research Officer Jason Goepfert:
“This threshold generally serves as a good delineator between healthy and unhealthy markets. During persistent bull markets, the model consistently levitates above 60%. When it stays below 60% consistently, sentiment is poor and periods of recovery tend to bring in sellers.”
The chart above shows that Dumb Money Confidence loosely tracks the S&P 500. When the market is going well, the dumb money gets more bullish and vice versa. The last couple of times it significantly rose, it quickly peaked and equities turned as well. That implies that the next down leg is imminent. So far this year, as the chart below shows, Dumb Money Confidence has continued to tend to chase the S&P, and the 60% barrier has twice acted as a point at which the market turns down (bringing traders’ confidence with it):
What does this tell us? And will it happen again? For Goepfert, a recovery in sentiment is typically a good thing, except during a bear market:
“If we look only at recoveries in bear markets, it’s clear that further gains tend to be muted. Almost by definition, forward returns will be weak, and this is only backward-looking. We don’t know ahead of time whether it will be a bear market signal or a new bull market one.”
In other words, the key question is whether the bear market is really over. If it isn’t, then we’re approaching the end of this rally. And if it really is, there is much, much further to go. A few more trading sessions of rising dumb sentiment and rising share prices would begin to build momentum that would be hard to stop.
All of this is about sentiment. At some point, it could founder on cold economic reality. Quite apart from betting against the Fed doing what it says it will do, and making it harder for the Fed to tighten financial conditions, the dumb money is making a courageous wager on a soft landing. It’s hard to see any other way that rates and inflation will come down swiftly without inflicting any damage on the stock market. Soft landings are difficult, particularly in the current atmospheric conditions.
Some Actual Good News
There are, it is true, some new data that suggest it could happen. This week’s ISM surveys of supply managers in both manufacturing and services for the US show very sharp drops in the prices that managers said they were having to pay. However, the overall level of activity they reported remained robust. So that one data point, at least, suggests that the US economy is at this moment on course for a soft landing:
So, yes, a soft landing could happen. But it would do so amid a wave of fear about a recession, and at a point when sentiment in the equity market seems to have turned infeasibly positive. And the frustrating part, emphasized by Goepfert of SentimenTrader, is that there isn’t much we can do with this data for now except to wait:
“It’s not clear at the time of the recovery in sentiment whether it might present us with a good opportunity to buy or sell... This is more of an attitudinal check. Sentiment has moved out of a pessimistic extreme, and during bear markets, it doesn’t usually get a chance to recover much more before sellers sense an opportunity. During bull markets, those sellers usually get rolled right over. Whichever behavior we see in the weeks and months ahead will determine whether long-term investors would best be served by adding more exposure.”
The odds remain that this is a bear market rally, because the economic situation remains stacked against equity bulls. But we can’t be certain, and that’s infuriating. The best strategy for now is probably to stick with balanced asset allocation, and with decent high-quality stocks. If the bulls win the day, then the dumb money crowd will do better than this, but you’ll still be fine.
—With assistance by Isabelle Lee
OK, women’s sports. They’re really good. We’re used to women in tennis. Try this Martina Navratilova vs Steffi Graff semifinal at the US Open from 1991, or this semifinal from 2000, pitting Martina Hingis against Venus Williams, which I was lucky enough to see live — it’s competition at its greatest. And we’re also used to women in gymnastics; nothing will ever top the perfection of Nadia Comaneci. But it’s even more fun to see women playing sports that men are accustomed to reserve for themselves.
England is still excited by the Lionesses’ victory over Germany (of course) to win the women’s European Championship of soccer last week, although the quarterfinal against Spain was better (and won with a great goal), while this goal in the semifinal against Sweden was ridiculous. There’s something very liberating about watching women celebrate, free from the testosterone that can mar the festivities when men are victorious; when England’s women interrupted a press conference it was delightful, but I’m not sure it would have come off the same way if the men’s team tried it. The USA has been into women’s soccer at least since the 1999 World Cup, which also ended with a famous celebration involving a sports bra.
Now to admit some bias. The minor league men’s football club that has its ground next to my old high school really discovered something when it decided to pay its women’s team the same total wages as the men. That bought them a team that was capable of beating Liverpool, and hammering others. And when women play rugby, it’s great to watch, too. Particularly when your daughter’s on the team and they win the championship. It’s empowering to behold. And is it really so much less entertaining when played by women rather than muscle-bound men?
This column does not necessarily reflect the opinion of the editorial board or Bloomberg LP and its owners.
John Authers is a senior editor for markets and Bloomberg Opinion columnist. A former chief markets commentator and editor of the Lex column at the Financial Times, he is author of “The Fearful Rise of Markets.”