By Philip Lawlor, head of Global Markets Research
Technical measures of investor confidence (or fear) are useful tools for gauging impending contrarian shifts in equity market performance. So what are these sentiment indicators telling us now?
Our proprietary Composite Sentiment Indicator (CSI) blends four technical barometers of investor sentiment—I.e., the breadth of stock overbought and oversold Relative Strength Indicators (RSI) and the percent of stocks hitting their 52-week highs or lows—into a single Z-score. CSI scores measure the degree to which current readings are above or below their long-term averages, and range from 1 (levels deemed extremely oversold/fear) to 5 (extremely overbought/overconfidence).
Peaks and troughs tend to be brief and reverse rapidly
The chart below illustrates the sharp gyrations in world equity-market sentiment in response to the coronavirus outbreak and its economic impact. After nearly hitting a 15-year record high in late January, the FTSE World Index CSI score plunged to extreme pessimism or fear (to a score of 1) through late March. It then bounced back to confidence highs through early June as markets climbed a wall of worry.
As shown, readings at either extreme tend to be short-lived and followed by sharp reversals. A contrarian investing approach to these shifts in sentiment readings would have been beneficial: lightening equity positions as the indicator peaked in January and topping up positions when it approached its March lows.
Since its June peak, the CSI reading has eased back to neutral territory, suggesting momentum behind the breakneck rally since late March may be cooling.
FTSE World Index Composite Sentiment Indicator (Z-scores)
Source: FTSE Russell / Refinitiv. Data through June 15, 2020. Past performance is no guarantee to future results. Please see the end for important disclosures.
The global nature of the coronavirus outbreak also drove a convergence in the equity return patterns. After declining to neutral (and negative) levels between 2016 through 2017, correlations between the US Russell 1000 and other major stock markets have turned increasingly positive, approaching a near perfect 1:1 uniformity most recently—in line with previous peaks since 1991.
Rolling 12-month regional equity-market correlations with Russell 1000 Index (three-month returns, local currency)
Source: FTSE Russell / Refinitiv. Data as of June 15, 2020. Past performance is no guarantee of future results. Please see the end for important legal disclosures.
Interestingly, correlations between US large caps and emerging markets deviated most significantly during the Taper Tantrum in 2013, when then-Fed Chair Ben Bernanke announced the impending slowing of Fed asset purchases, and again in 2018, as the Fed was raising rates and US financial conditions tightened. The Russell 1000 and the FTSE Japan have also experienced several periods of negative correlations, particularly during the 1990s, with the collapse of the Japanese real estate bubble.
The combination of ebbing investor sentiment and near-perfect uniformity among global equity markets suggests that any slowdown in the momentum of the post-lockdown rally is likely to be pervasive.
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