Updated December 6, 2022
Raymond Micaletti, Ph.D.
As we were trying to make sense of the latest macro data on growth, inflation, jobs, European winter, et al., we came to the realization (not for the first time) that qualitative macro data is often simply noise.
Is it time to panic over Europe once again? A month or two ago, Europe was all but left for dead on account of unrelentingly high natural gas prices. Then, it turned out Europe had pre-filled its natural gas storage facilities to 90% of capacity before winter, leading pundits to believe things weren’t as bad as feared. But now an arctic cold front might be headed its way…
Is the Fed tightening or not? The Fed is supposedly reining in financial conditions with “quantitative tightening” (QT). Contemporaneously, however, the U.S. Treasury is drawing down its General Account and the Fed is engaging in reverse repurchase agreements. Both actions function similarly to “quantitative easing” and thus counteract the Fed’s QT.
What’s the real state of the jobs market? The latest jobs report on Friday came in hot based on the establishment survey (which has shown approximately 3 million jobs created this year). But the household survey showed a loss of 138 thousand jobs and has shown only about 120 thousand new jobs for all of 2022.
Are we growing or contracting? The Atlanta Fed’s GDPNow currently estimates Q4 GDP at 2.8%. But professional economists are forecasting -1.9% growth (the last we read). That’s a huge divergence. Who’s right?
Given this muddled picture across the board, we’ve decided henceforth to focus our commentary almost exclusively on the most powerful factor most people have never heard of—relative sentiment—for the following reasons:
It’s objective and can be tested against past market behavior.
It’s provided more signal than noise in a challenging 2022 (bearish equities until late June, ultra-bullish equities in mid-October, bullish the dollar until mid-October, bearish gold from mid-June, bullish gold from mid-November, etc.).
We have no particular expertise in qualitative macro analysis—indeed virtually all of our intermediate-term macro beliefs tend to be based on relative sentiment.
Institutions, in the aggregate, expend considerable resources poring over every imaginable piece of data to discern the state of corporate and economic fundamentals. Ultimately, those institutions arrive at their conclusions and make their bets. How they bet is a reflection of their beliefs and thus a reflection of the perceived fundamentals.
Therefore, we would posit that our focus on the positions, flows, and attitudes of institutions (the ‘smart money’) compared to individuals (the ‘dumb money’) is the equivalent of the jock letting the nerd study for the exam and then copying the nerd’s answers to pass.
We like life hacks.
This isn’t to say relative sentiment will always be right (it won’t) or that there’s no value in qualitative macro analysis, rather it’s a realization that we can add more value by presenting the unique insights of relative sentiment than by being just another voice hypothesizing about what the latest macro data might be saying.
(And just as market technicians would say the fundamentals are baked into the price, we would submit that the fundamentals are baked into how institutions have positioned themselves relative to individuals.)
So, what is relative sentiment saying now?
Relative sentiment in equities, currencies, commodities, and liquidity-related assets (e.g., short-term bonds, Eurodollars, Fed fund futures) are all saying that the rally in risk assets likely has further to go. At the same time, there are hints that in a few weeks’ time, we may start to see a less bullish (or even bearish) landscape.
Equity relative sentiment reached the rarified level of 92% last week (extreme bullishness), driven by positive changes in Sentix survey-based relative sentiment and cross-asset relative sentiment.
At the same time, our measure of position-based equity relative sentiment shows clear signs of waning bullishness. Moreover, macro retail sentiment, while uniformly in the “goldilocks zone” (for equities) at present, has fallen precipitously recently and if commodities continue lower we would expect its reading to fall as well.
Thus, while our survey-based and cross-asset relative sentiment measures are likely to hold steady (at 87% and 80%, respectively), it’s conceivable we could see our positions-based relative sentiment and macro retail sentiment fall to zero in the coming weeks. This would cause our composite measure to fall from 92% to 41% and would be a warning sign that the recent rally might be coming to an end.
Certain cross-asset relative sentiment relationships currently also bode well for emerging and developed markets. In fact, emerging equities have historically outperformed U.S. equities by about 200 bps per annum when the stars have aligned previously as they do now with respect to relative sentiment measures of growth and liquidity.
On account of the aforementioned growth and liquidity measures, it appears as though Energy and Materials are the sectors most likely to outperform in the near term.
Conditions are also generally favorable for Technology, Consumer Discretionary, and Industrials, though not as favorable as for Energy and Materials. The reason is that dollar relative sentiment is bearish, which historically has been more of a tailwind for Energy and Materials than it has been for those other sectors.
Conditions are moderately favorable for Healthcare and Consumer Staples.
Conditions are generally unfavorable for Utilities and Financials (relative to the other sectors), primarily because dollar relative sentiment is bearish (both sectors strongly prefer bullish dollar relative sentiment).
Relative sentiment conditions are generally favorable for bonds and credit spreads.
It all starts with the U.S. dollar. Dollar relative sentiment is bearish, which historically has been:
Bullish for the 10Y and 30Y bonds
Bearish for real yields (and thus bullish for TIPS)
Further, while the yield curve has inverted to an extreme degree this year and relative sentiment suggests it could continue, we appear to be nearing a turning point.
Flattening or steepening of the yield curve (10-year minus 3-month) tends to be primarily driven by relative sentiment in the 2-year bond. When it’s bullish, the curve flattens and vice versa. It’s currently bullish, but only marginally so and could easily turn bearish in the next couple weeks.
Similarly, high-yield credit spreads are also driven by relative sentiment in the 2-year bond (in the same way as the yield curve). Bullish 2-year relative sentiment (which has been the case all year) suggests widening spreads—CCC spreads over 10-year Treasuries have widened more than 600 basis points this year.
But if 2-year relative sentiment turns bearish (and it appears as though it may do so within the next few weeks), we may start to see a narrowing of high yield spreads (which, in turn, might keep the “risk-on” party going).
Once again the main driver here is dollar relative sentiment.
In particular, relative sentiment conditions are ideal for gold. Bearish dollar relative sentiment coupled with falling real rates (real rates have fallen over 70 bps since dollar relative sentiment turned bearish in mid-to-late October) is one of the best combinations for the precious metals sector.
Gold is up 12% since dollar relative sentiment turned bearish and up 2% since real rates flashed a negative momentum signal in mid-to-late November.
In addition, mining stocks moved strongly higher intraday on Friday, closing above their 200-day moving average (after opening lower on the jobs report). Intraday strength in miners is predictive of follow-on strength in the precious metals complex. So, we would expect further gains for gold and silver and mining stocks in the days and weeks ahead.
Conditions are also currently bullish for oil and gasoline, but only marginally so. We expect conditions to turn bearish for oil and gasoline in the next couple weeks. If so, we may see macro retail sentiment in commodities fall out of the goldilocks zone and impact our equity relative sentiment (to the downside).
Value vs. Growth
Relative sentiment (in growth-related commodities and liquidity-related fixed income and currencies) suggests Growth may outperform Value in the near term. It’s not quite a slam-dunk case, however, as the liquidity-related metrics are hovering around zero and could whipsaw in such a way that Value would appear more attractive. We should have more directional resolution in the next few weeks.
Relative sentiment in equities, the dollar, and various growth- and liquidity-related assets suggest that the recent rally we have seen in equities, bonds, and gold has further to run.
Non-U.S. equities may continue their recent outperformance.
Energy and Materials appear to be the sectors most likely to outperform.
Growth appears poised to outperform Value.
Real yields are likely to remain under pressure, so long as dollar relative sentiment remains bearish.
High yield credit spreads appear to be on the brink of narrowing (should trends in relative sentiment continue)—which would likely prolong the market’s “risk-on” mindset.
Despite the near-term support for risk assets, however, the window of opportunity doesn’t appear open-ended. Trends in certain measures of equity relative sentiment suggest those measures could turn bearish sometime in December.
Moreover, we are moderately concerned about the dollar and real yields bouncing given their dramatic selloff over the last several weeks. Typically, assets don’t move in a straight line (up or down). Further, the Energy sector is struggling at resistance and a pullback wouldn’t be surprising.
Thus, while we do expect the recent trends to continue (so long as the various relative sentiment metrics maintain their current sign—bullish or bearish), a dollar or real rates bounce might make things interesting along the way.
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