Mid-week market update: This market is in need of a reset in investor sentiment. In addition to recent reports of frothy retail sentiment, the latest BoA Fund Manager Survey (FMS) indicates that global institutions have gone all-in on risk. The FMS contrarian trades are now “long T-bills-short commodities, long US$-short EM, long staples-short small cap”, or short market beta.
Along with growing signs of deteriorating market internals, this market is poised for a correction.
More signs of froth
Here is how frothy sentiment has become. SentimenTrader
recently reported sky-high call option activity by retail investors.
In aggregate, speculators (read: hedge funds) are very, very long equity futures.
This is the classic definition of a crowded long position by different constituents. Retail, hedge funds, and now institutions are all long risk up to their eyeballs. Who is left to buy?
All the market needs to fall is a bearish trigger. Even as the S&P 500 staged an upside breakout to another all-time high, a number of worrisome negative divergences are appearing.
- Technical: A negative divergence from the 5-day RSI.
- Equity risk appetite: The ratio of high beta to low volatility stocks is trading sideways and not confirming the new high. This ratio is an important indicator of equity risk appetite.
- Earnings season reaction: Q4 earnings season has begun. Most of the large-cap banks have reported, and most have beaten expectations. However, financial stocks are lagging the market despite the beats. A market that does not react well to good fundamental news is a warning for the bulls.
- Foreign exchange risk appetite: The USD has been inversely correlated stock prices. The USD began a counter-trend rally, which would put downward pressure on risk assets.
recently highlighted the crowded short positioning in the USD Index. This makes the EM assets especially vulnerable, and the long EM trade is a long risk and reflation trade.
The cyclical and reflation trade is also in need of a reset in sentiment. Callum Thomas
observed that the S&P 500 does not perform well when ISM rises above 60. Too far, too fast?
From a sentiment momentum perspective. the FMS shows that the expectations for the Goldilocks scenario of strong non-inflationary growth is rolling over. These are the kinds of conditions that can spark a correction.
In conclusion, the combination of giddy sentiment and technical deterioration is not a good recipe for further equity market gains. The short-term risk/reward ratio is negative and the market can correct at any time.
Disclosure: Long SPXU