How investor sentiment can move markets

Stocks move most on the gap between reality and expectations, with current data showing more gains ahead

A trader at the New York Stock Exchange. The Bank of America’s February fund manager survey revealed the most bullishness since January 2022. Reuters
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So far, so good! My 2024 outlook called for a good-to-great year, and the 4.8 per cent global returns up until February 27 speak to just that. More gains await.

One key reason? Sentiment. Stocks always move most on the gap between reality and expectations, so gauging the latter is key to any outlook.

There are hard ways to assess this. But also easy ones anyone with web access can do.

Today, easy or hard, both methods reveal dourness dominates – paving the bullish road forward.

Legendary investor Sir John Templeton famously said: “Bull markets are born on pessimism, grow on scepticism, mature on optimism and die on euphoria.”

Recent years are examples: After 2020’s rocket ship market recovery from Covid lockdown lows – itself born in despair – sentiment warmed unusually fast in 2021.

Frothy pockets emerged in speculative assets like crypto and special purpose acquisition company initial public offerings, making stocks susceptible to negative surprises.

Then came Ukraine, inflation, central bank rate hikes, supply chain chaos and more. The result? The small-sized bear market in 2022.

Yet, by October 2022, long-running fears drove irrational pessimism, ushering in the positive surprise that birthed this beautiful bull market.

Now, sentiment has warmed somewhat – to scepticism.

Consider this: The Bank of America’s February fund manager survey revealed the most bullishness since January 2022, while many other surveys show similar outlooks.

Yet, bears take this too far, arguing that we fast-forwarded to optimism … even euphoria!

They point to stale fears like the Israel-Gaza war and eurozone economic weakness as “evidence” investors are too cheery, setting stocks up to fall – while claiming only a handful of stocks (the Magnificent Seven) underpin this bull market.

Wrong! Nearly a third of global stocks lead the world in the year-to-date.

So, how can you see sentiment relatively clearly? One tough way my company does, but you probably can’t replicate, is illustrative: Plotting professional sentiment bell curves.

Wall Street forecasts both reflect and influence sentiment. My company collects dozens of them from everywhere.

The aim? Revealing which outcomes are widely expected and discussed … and which aren’t. This doesn’t reveal what will happen – stocks pre-price common forecasts and do something different.

But it shows what people think will happen and hence is already priced in stocks – a sentiment signal.

Consider median S&P 500 forecasts versus actual returns in recent years: At 2018’s start, the median forecast saw 5.3 per cent gains excluding dividends. Reality? Stocks fell 6.2 per cent.

In 2019, the median was 15.8 per cent gains – yet stocks crushed it, rising 28.9 per cent.

Last year's forecasts versus expectations were at 9.4 per cent, way below the actual 24.2 per cent.

Starting this year, the median was just 1.8 per cent – way below US stocks’ long-term 10.2 per cent annualised average return without dividends, which includes bear markets. It’s hard to see 1.8 per cent as “too optimistic”.

Don’t stop at median forecasts. Look deeper.

Out of 54 professional S&P 500 2024 forecasts, 40 cluster between 2.9 per cent and 9 per cent returns – while nine see declines worse than 3 per cent. None see returns exceeding 17.1 per cent.

The greater prevalence of lacklustre or negative returns than double-digit gains show you sentiment isn’t near euphoria. It is middling at most.

The relative void above 10 per cent suggests above-average gains. All this is hard to do.

There are easier tools you can use. One: Track how economic data compares to estimates.

You can find consensus forecasts for global gross domestic product, inflation, employment, purchasing managers’ indexes and more on many financial and economic news websites.

Then, as outcomes are announced, compare the results to the expectations. Are they worse than expected? Then, sentiment is probably too optimistic.

Are they better? Too dour! As expected? In the middle.

Recently, most key data are trending above estimates – thanks to lingering inflation and recession fears.

Stocks always move most on the gap between reality and expectations, so gauging the latter is key to any outlook
Ken Fisher, founder, executive chairman and co-chief investment officer, Fisher Investments

Another way: Consider IPOs. I have long said IPO actually means “It’s probably overpriced”, given companies do IPOs when prices are best for sellers (founders and early investors) – not buyers.

Heavy issuance usually follows a big rise, when recent returns boost spirits and elevate demand, allowing top dollar pricing.

Earlier IPO successes often fan optimism further, leading to more lower-quality listings flooding markets.

Hence, sunny sentiment is detached from weakening fundamentals.

The Middle East’s strong 2023 was an exception to the global IPO desert.

Now? US and European issuances are up from last February, and analysts see more ahead.

But issuance remains muted overall – revealing scepticism, maybe some optimism but certainly not euphoria.

Many companies issuing shares lately use the proceeds to retire costlier debt. Plus, today’s IPOs are more established – think ARM and Shein – unlike 2021’s speculative Spacs.

Nothing euphoric there.

Whether you choose easy or hard methods, tracking sentiment is key. Today, it all signals more gains ahead.

Ken Fisher is the founder, executive chairman and co-chief investment officer of Fisher Investments, a global investment adviser with $200 billion of assets under management.

Updated: March 06, 2024, 8:51 AM