Market sentiment made a renewed low two weeks ago, matching the extreme bearishness in mid-January of 2016. The levels recorded on the weekly Bullish Sentiment Index published by the Association of Individual Investors (AAIIBULL Index on Bloomberg), both in mid-January and mid-February 2016, are among the lowest handful of readings in a decade, as well as within the lowest dozen weekly readings since mid-1987 when this index first started being published (see Chart 1). Sentiment got to such bearishness based on a fear of a hard landing in China, an ever declining oil price that would cause bankruptcies, the possibility that the US is headed for a near term recession, and that policy makers are out of ammunition in a world where global growth and inflation are both faltering badly. Markets believed that in early 2016 the world is in a crisis rivaling the many crises experienced in the past 25 years including the Asian debt crisis of 1997-98, the Internet Crash of 2000, the terrorist event of September 11, 2001, the Lehman bankruptcy and Great recession that ensued, the European debt crisis of 2010-12, the US Treasury credit downgrade of 2011, etc.
Since that low point in sentiment, Chinese officials have been able to dispel the notion that a hard-landing in growth and a significant devaluation of the Yuan is quite likely in the near term. Oil prices have stabilized above $30 a barrel (and even risen by 20% off the lows). The talk of a US recession has faded somewhat as US economic data have begun to surprise on the upside after a long spell of more than a year of weaker than expected readings (see Chart 2). The Atlanta Federal Reserve, which computes an ongoing estimate of current quarter GDP, now has a running estimate of 2% for Q1 2016 GDP, after a dismal performance at 1% in Q4 of 2015.
On the inflation front, US inflation is also showing signs of picking up from low levels, as readings on CPI, PPI, and PCE have all surprised on the upside. This welcome increase in inflation in the US justifies the Federal Reserve’s (Fed) decision to take a first step to begin a normalization of rates in December of 2015. It also reflects the fact that labor markets are better, and that consumers are more willing to spend with higher incomes and low energy prices. The US housing market continues to benefit from low mortgage rates that are unlikely to spike higher any time soon due to a cautious Fed.
Central banks have been perceived as running out of ammunition as interest rates in Europe have plunged to negative levels across a range of maturities up to 7 years, the Bank of Japan has moved the deposit rate to a small negative level, and ten year maturity Japanese government bond yields have also turned negative. Negative interest rates are correctly perceived by market participants as abnormal, and problematic, especially for the banking sector. Even the Fed acknowledged that they are studying the theoretical possibility of negative rates for future needs, though it is unlikely that such a tool would ever be utilized in the US. An important series of central bank meetings around the world is just ahead of us: the ECB on March 10th, the BoJ on March 15th, followed by the Fed on March 16th. As a rule, it is generally not wise to wager that central banks will be unable to affect market psychology for long, though the BoJ’s recent unexpected easing engendered a negative reaction. We would expect even better sentiment readings
after the upcoming set of central bank meetings and policy decisions.