New year, same old… story. At least, that is what the price action from the first few trading sessions of 2017 suggests. Reflationary Trumponomics, counterbalanced by ongoing concerns that US equity markets are priced for perfection abound, and following the shock election results of last year, worries about political risk are extremely elevated. Indeed, some have suggested that it is at its highest level in the post-war period with considerable uncertainties surrounding Russia, China and North Korea and the nature of their future relationships with the incoming US administration.
Having already reflected on the key themes evident in the multitude of year ahead outlooks offered up by sell-side and buy-side institutions in the final Market Insight of 2016, one has no wish to repeat the exercise. Rather, in this Market Insight, one considers the market themes most evident in the crowd-sourced sentiment data across the major asset classes by concentrating on the extremes: most loved and most hated. Two diametrically opposed emotional states but which, as the old adage goes, represent two sides of the same coin.
Starting off with global currencies, no surprise in terms of which currency is the most loved by the crowd – the dollar.
The above “layers” chart may at first glance appear complex as it conveys a considerable amount of information. However, once properly understood, it is actually rather simple and extremely useful as it allows one to make across-asset comparisons between the latest sentiment reading and an earlier period – in this instance the dates being January 2rd, 2017, and a month earlier, December 3rd, 2016.
It is possible to set the ranking order according to several parameters, but in this and all the other examples included in this Market Insight, the ranking is defined according to the sentiment level at the end date. The sentiment levels are colour coded (from blue/green, implying negative readings, to red implying positive readings) and displayed in the middle layer – hence the chart’s name.
What one can observe from the above chart is that dollar sentiment stands at 2.24 – the highest reading of all the 30-odd currencies included in the chart i.e “most loved” – and that over the past month sentiment has been stable (as evidenced by the zero reading on the very outer layer, which is the difference in sentiment readings over the two dates chosen). That is to say, crowd sentiment towards the dollar has stabilised at a historically elevated level. By contrast, the currency with the lowest crowd sentiment score, i.e the “most hated” is the Turkish lira, with sentiment having fallen to -1.4.
For naturally predisposed contrarian investors, such extreme sentiment skews make it tempting to go against the prevailing view, suggesting a short dollar/lira position as a winning strategy.
However, the interaction between sentiment and price is not that straightforward (sorry – the Holy Grail does not exist in finance). As mentioned in an earlier Market Insight, when analysing sentiment data (equities in this earlier case) one finds a positive correlation between short-term future price changes and sentiment, but a negative correlation between long-run returns and the level of sentiment – i.e. there is a shorter positive momentum effect and a longer negative contrarian effect.
While a significant sentiment skew constitutes a useful first sentiment signal (one labels this effect “crowd fail” for reasons defined in a previous Market Insight), it becomes more powerful when the skew begins to unwind because at this juncture both the short-term and long-term correlations are aligned.
Indeed, looking at crowd-sourced lira sentiment versus the dollar/lira spot rate since January 2005, one can see several instances where sentiment towards the Turkish currency has been as weak or weaker than the present reading and is in the process of reversing. In all but one of these instances, the summer of 2013, the Turkish currency managed to buck the long-term depreciating trend warranted due to its higher relative domestic inflation rate (consistent with uncovered interest rate parity).
Referring back to the first chart above, crowd-sourced sentiment towards the Turkish currency has fallen by 0.56 over the past month, indicative of a still increasingly negative mindset. Hence, while the market conditions are being created for a short squeeze in the lira at some stage during 2017, one does not appear to be at that point in time at present.
Scanning across the crowd-sourced sentiment data in the other major currencies, one candidate that does jump out is the Swedish krona (SEK). Having been one of the worst performing of the major currencies last year, surpassed only by the Brexit-hit pound, crowd-sourced sentiment fell to multi-year lows in early November, but is now in the process of being reversed: sentiment over the past month having risen by 0.6.
Such dissipation in the crowd’s negative outlook for the krona suggests 2017 is starting off much more constructively, highlighting the potential for further appreciation in the Swedish currency. The same is also true for the Hong Kong dollar and the Singapore dollar, albeit less strongly.
Applying the same methodology to the other asset classes, a few more interesting candidates arise. Amongst commodities, on the short side the standouts are soybeans, sentiment having dropped from an extremely high reading of 3.39 in early December to 1.44 on the latest data (suggesting there is still considerable scope for further capitulation) and iron, where sentiment has only just started to turn down from the peak witnessed in mid-December. By contrast, on the long-side, orange juice and sugar are the most interesting given that crowd sentiment has become notably less negative, but is still a long way from positive, or even neutral, suggesting further upside price potential.
Finally, in terms of global equity indices, while many investors are still torn between a positive growth impetus from Trump’s anticipated macroeconomic policies and worries over valuations – as alluded to at the outset – our crowd-sourced sentiment indicators show no strong sentiment skew on Wall Street at present having effectively unwound the negativity that defined most of last year.
The interesting candidates thrown up by the equity index layers chart (see chart below) are Singapore equities, where crowd negativity is dissipating markedly (an encouraging sign) and, at the opposite end of the spectrum, Indian and Chinese equities where previous crowd positivity is being eroded. In the case of India the disruption relating to the abrupt demonetization process has clearly been a damping factor, but whose one-off nature may be a mitigating factor. Yet, for China equity bulls enjoying the first flush of positive price action of the year, at a minimum, the downturn in crowd sentiment should provide pause for thought.
So, there you have it, what’s loved and what’s not in the world of financial assets by the crowd as one heads into yet another financial year, one that will unquestionably be full of surprises.