In recent times, the financial markets have been navigating through a plethora of challenges, with geopolitics, investor sentiment, and asset allocation at the forefront of these trials. This article delves into these complex domains, aiming to shed light on the intricate dance between geopolitics and investor behavior, and how these elements interplay to shape market dynamics. Through an examination of recent market trends and investor strategies, we strive to offer insights into the current state of the financial markets, paying close attention to stocks, bonds, and the burgeoning interest in energy stocks amidst fluctuating oil prices.
At this juncture, the S&P 500, a bellwether of market health, has recently recoiled to levels below 6000, a movement attributed largely to geopolitical strains. Historically, the impact of geopolitics on markets has been mixed. While many geopolitical events have temporarily jostled the markets, causing brief spells of volatility, their long-term impact has often been negligible, providing astute investors with potential buying opportunities. However, certain geopolitical occurrences, especially those materializing at vulnerable market junctures or those exacerbating underlying economic stress points, have demonstrated the capacity to precipitate more pronounced market downturns. The Russian invasion of Ukraine in 2022 serves as a pertinent example, when an already overvalued stock market succumbed to the added pressures of surging commodity prices and escalating inflation.
The reverberations of geopolitical tensions are felt differently across various investor segments. On one hand, investment managers, who are already navigating a landscape marked by high valuations and policy uncertainties, have shown a cautious stance, as evident from subdued risk appetite indicators. On the other hand, retail investors, as tracked by indices such as the Schwab Trading Activity Index, also display a cautious approach, with a trend of capitalizing on market rebounds to book profits, underscoring a broader sentiment of uncertainty.
Moreover, the landscape of investor euphoria and allocation strategies has presented an intriguing narrative. Despite the fleeting nature of recent corrections, indicators of investor euphoria remain elevated, suggesting a market that is perhaps too optimistic, verging on cautionary territory when analyzed through a cyclical lens. Additionally, the persistent influx of foreign capital into US equities over the past decade, a trend showing initial signs of reversal, further complicates the sentiment and positioning narrative, potentially foreshadowing shifts in global asset allocation preferences.
Amidst these underlying currents of investor sentiment and geopolitical uncertainty, the allocation of assets between stocks and bonds presents another layer of complexity. With equity allocations reaching historical highs and debt investments touching 40-year lows in the US, the landscape is ripe for rebalancing, especially considering the gyrations in market sentiment and the potential for shifts in investor strategies. This delicate balance between stocks and bonds is further intertwined with the dynamics of market cycles, where timing and the nature of geopolitical events play crucial roles in shaping outcomes.
Energy stocks, in particular, emerge as a segment warranting attention. Characterized by their unpopularity and undervaluation, coupled with a general lack of preparedness for potential oil price surges, energy stocks represent a sector that could be on the cusp of significant market reevaluation. As investors grapple with the broader market implications of geopolitical unrest and shifting sentiment, energy stocks may offer avenues for value realization, highlighting the importance of sector-specific considerations in portfolio management.
In conclusion, the interplay of geopolitics, investor sentiment, and asset allocation strategies in shaping market outcomes underscores the complexity of financial markets. As investors navigate this labyrinth, informed by historical precedents and attuned to current market dynamics, the importance of a nuanced understanding of these elements cannot be overstated. With the backdrop of geopolitical uncertainty, evolving investor behavior, and sector-specific opportunities, particularly within energy stocks, the financial markets continue to offer a rich tapestry for analysis, presenting challenges and opportunities in equal measure.
This week: technically ready, geopolitics, sentiment and positioning, asset allocations, stocks vs bonds, market cycles, energy stocks…
Learnings and conclusions from this week’s charts:
- Stocks are stumbling on geopolitics (S&P 500 back below 6000).
- Most of the time geopolitics can be ignored, with some exceptions.
- Sentiment remains mixed, skittish, still skewed bearish/defensive.
- Yet investor allocations to stocks are historically elevated.
- Energy stocks are unloved, undervalued, and unprepared for oil price upside.
Overall, a key theme to think about this week is timing. As I point out, when you study market technicals, you find events/excuses have a habit of showing up at times when the market was ready to move but just waiting for an excuse. Likewise, when it comes to geopolitics, the nature of the event matters —but more importantly; the stage of the market cycle and wider pressure points matter most. Fortunately you have people like me Monitoring The Situation on both of these fronts, let’s take a look…
1. Roundnumberitis? Funny thing about markets and macro is that events/excuses tend to show up around technically convenient points. I mentioned this the other day with regards to rebounding off a major long-term support level and big washout in sentiment — but we also have an example here with the stumbling just after retaking that big 6000 round number.
Source: MarketCharts
2. Geopolitics: In case you missed it, the excuse/event was Israel taking action on Iran. Now, I’m not going to pretend to know what’s going to happen next there, but I include the table below for a couple of reasons.
First is to keep things in context, a lot of geopolitical events, even major ones, have barely budged markets in the past aside from an initial knee-jerk, and in many instances the initial panic selling was a buying opportunity.
But there are examples where the events were more significant, or came at a time where the market was vulnerable, or triggered off macro pain points. A prime example of that was the 2022 Russian invasion of Ukraine; the stockmarket was extreme expensive and sentiment was all-in late-2021… so it could have taken any excuse to trigger downside; but you also had the flow-on effects from the invasion which were a spike in commodity prices and inflation (macro pain points).
The risk case here is that we’ve already rebounded back to expensive levels for stocks, and sentiment is a bit skittish at the moment, and there is a tail risk of oil price shocks — so while we want to keep things in perspective, it would be wrong to dismiss downside risks entirely.
Source: @RyanDetrick
3. Investment Managers: Speaking of sentiment let’s take a look at a few key datapoints. First is investment manager sentiment — risk appetite has begun to recover, but overall investment managers remain fairly pessimistic/defensive as concerns remain elevated around: valuations, (geo)politics, and policy (e.g. fiscal largesse vs monetary policy constraints, and generalized uncertainty).
Source: Investment Manager Survey
4. Retail Investors: According to the Schwab Trading Activity Index, retail sentiment likewise remains subdued, with Schwab clients apparently taking profits on previous dip-buying, and using the rebound in stocks as a selling opportunity.
Source: Schwab Trading Activity Index
5. Investor Euphoria Cycles: As for my slower-moving Euphoriameter (which combines forward PE ratios with smoothed inverted , and smoothed bullish surveyed sentiment), it’s still quite high. Partly due to the only brief and fleeting nature of the correction, this indicator only saw a partial reset from record high levels. This indicator remains in warning territory from a cycles analysis standpoint; you get concerned when things like this reach high levels and then roll-over. Albeit some might argue the correction earlier this year was simply a late-cycle reset.
Source: Topdown Charts
6. Foreign Investors: Another key sentiment/positioning datapoint has been the initial reversal of a decade of major foreign inflows into US equities. This remains an elephant in the room because it has the potential for an unwinding of previous tailwinds (where foreigner rotation back out of US equities could become self-reinforcing). Even if we discount that though, it’s hard to see this tailwind persisting in a way that it did over the previous decade.
Source: Topdown Charts Professional
7. Sentiment vs Allocations: Also of interest is the sentiment vs positioning aspect. Surveyed sentiment crashed in April to one of the worst readings on record. But AAII and ICI information on investor portfolio allocations to equities showed only a minor adjustment, and likely a big portion of that was simply market movements. In other words, despite all the pessimism, investors didn’t really vote with their feet.
Source: Topdown Charts
8. Asset Allocations: And here’s another angle on that, aggregate allocations within the USA to equities reached an all-time high. Meanwhile, allocations debt investments are at 40-year lows…
