When stock market‘s mood starts to flag, things can get dicey in a hurry.
That’s been especially true in 2018, as pent-up volatility positions have exacerbated losses during turbulent times. There are also plentiful crowded positions, which can crumble on any sign of weakness as traders rush to the exits.
Luckily, Bernstein maintains a sentiment indicator designed to track the speed at which equity fund flows are shifting, relative to the broader market.
Perhaps not so luckily, that gauge is sitting at the second-most pessimistic level in its 14-year history.
The other time it was this low? The first quarter of 2008, in the throes of the financial crisis, and a full year before the stock market bottomed.
What makes this indicator so scary is that it monitors the pace of sentiment deterioration, rather than reflecting some less meaningful absolute level. It suggests that traders are turning their back on stocks — and doing so in a hurry. As a standalone measure, it’s enough to make anyone fear the situation is spiraling out of control.
For worrisome signs, look no further than how the stock market has behaved this earnings season. Faced with mostly better-than-expected results — including strong reports from some of the market’s biggest names— major US indexes have limped along, with both the S&P 500 and Dow Jones industrial average headed for a second straight week of declines.
However, there are considerations floated by Bernstein that should put investor nerves at ease — at least in the near term. First off, the firm says the fast pace of US equity fund withdrawals may just be a byproduct of how quickly cash poured into those same funds during the first quarter.
Secondly, based on what happened the last time the sentiment gauge was this low (in 2008), the equity market should actually climb over the next 12 weeks. Due to the small sample size, this suggestion must be taken with a grain of salt, but there’s no denying it’s worked as a contrarian indicator on at least one occasion in the past.
So where does Bernstein come out in the end? It’s somewhere in the middle ground between the arguments they’ve laid out.
“We have found historically that when our indicator flags sentiment at such pessimistic levels that the market tends to respond positively over the following 12-week period,” Mark Diver, global quant and European equity strategist at Bernstein, wrote in a client note. “Whilst we believe that sentiment is supportive of gains to equity markets from here we are not yet making an outright contrarian tactical buy call due to mixed signals.”
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