A Despondent Market Waiting For Capitulation

Cross-asset positioning and sentiment are the most bearish since the onset of the pandemic.

Or at least according to one bank’s measure.

2022 has been challenging for investor psychology, to say the least. Hindsight is a helluva lens (as I’m fond of putting it), but it’s unclear why anyone thought this year would be smooth sailing. At no point post-Lehman have markets greeted the removal of monetary accommodation warmly. That aversion to any kind of tightening was evident to policymakers, who endeavored to smooth things over by implicitly giving markets a say — a veto, even — in policy deliberations. That arrangement is no longer viable due to soaring (and persistent) inflation.

Late last year, markets and policymakers attempted to come to some kind of consensus on the necessity of tightening, with the understanding that once inflation was tamed, things could go back to “normal,” where “normal” is a misnomer that refers to the dream state which defined the post-GFC era. “This functions as a reversed state of exception, which has the same pattern as waking up from a bad dream,” Deutsche Bank’s Aleksandar Kocic wrote, late last year. “The suspension of normal markets functioning is temporarily interrupted by allowing normal market functioning to take place, only so that it can be later suspended again to make room for administered markets to resume.”

But even that shaky arrangement was upended early this year. Inflation not only refused to abate, but actually accelerated. Then came the war, a historic commodities rally and, now, the prospect of severe stagflation, especially in Europe. All bets are truly off.

Little wonder, then, that sentiment is deteriorating rapidly. “Our aggregate measure of cross-asset positioning and sentiment has turned increasingly bearish since the start of the year,” Goldman’s Cecilia Mariotti and Christian Mueller-Glissmann wrote, in a Monday note. “The de-risking initially reflected a less friendly inflation/growth mix coupled with less supportive monetary policy across the major central banks, but more recently risk premia across assets, especially in Europe and part of EM, increased sharply due to the Ukraine/Russia conflict.”

The figures (below) tell the story. The bank’s aggregate measure of cross-asset positioning and sentiment is now “well below the 40th percentile,” a first since the pandemic bear market.

“Following the sharp risk-off triggered by the escalation in geopolitical tensions, our Risk Appetite Indicator has turned very negative and has repeatedly reached intra-day troughs of -1.7, before dropping to -1.8 as of Friday’s close,” Mariotti and Mueller-Glissmann went on to say.

Although equity inflows have been (very) robust YTD, it’s notable that credit flows have turned deeply risk-off. IG funds bled another $3.33 billion over the latest weekly reporting period on Lipper’s data, for example.

Do note, also, that global equity funds just witnessed their first outflow in 10 weeks (figure below).

That, Goldman wrote, means concerns around Russia’s invasion of Ukraine “are likely starting to spill over.”

The good news is, the dramatic turn in sentiment and positioning does suggest scope for a rebound. “At the current bearish levels… the asymmetry for subsequent equity returns starts to turn more positive,” Goldman said.

Flows are just about the only metric on which sentiment is still bullish (figure below). Maybe it’s not capitulation, but it’s certainly a kind of despondency.

Even as we may be tempted to chide ourselves for donning rose-colored beer goggles on New Year’s Eve, note that just as it’s not obvious why anyone should’ve harbored an overtly sanguine view on 2022, it’s equally unclear why anyone would’ve suggested, publicly, that the S&P 500 was on the brink of a 45% drawdown, as Jeremy Grantham did.

Some readers seemed to think my criticism of Grantham’s widely-publicized “prediction” (and the scare quotes are there for a reason) was gratuitous, but the problem with suggesting US equities are going to plunge by almost half in a compressed time frame is that such an outcome is all but impossible in an era when central banks have tacitly decided that outright crashes are unacceptable.

It’s certainly true that a controlled demolition of the variety described last month by Zoltan Pozsar could be socially beneficial at the current juncture (e.g., by helping to rein in inflation and by putting the brakes on the ever widening wealth gap), but no matter what anyone tells you, virtually no one benefits from the kind of collapse the likes of Grantham habitually predict. No one knows where the Fed put is struck these days, but suffice to say it’s higher than SPX 2400.

In any case, despite the notion that the outlook for equity returns is becoming incrementally more positive alongside deteriorating sentiment and bearish positioning, Goldman’s message was the furthest thing from an all-clear. “We would still be cautious, especially in Europe, as near-term the escalation in geopolitical tensions could continue and trigger further de-risking,” the bank warned.