Sentiment is a key driver of stock market returns in the short-term, notes RBC Capital’s Myles Zyblock. Fundamentals are more relevant for longer-term oriented investors. From his U.S. Equity Strategy Weekly note to clients:
Sentiment and value are cornerstones of the return generation process. We find that shifts in sentiment are critical on short-term investment horizons. For example, our work shows that changes in perception account for about two-thirds of the market’s return on a six-month horizon, and that even under the conditions of attractive value, bearish sentiment can drive prices lower and vice versa. Mean reversion is key to correctly using most sentiment gauges, where one attempts to arbitrage the belief that a recent trend will persist. Meanwhile, the market’s fundamental underpinnings become more important for investors with horizons that extend beyond a two-year time frame.
There are various measures of sentiment that stock market watchers follow. RBC blended six of the biggest ones to form one comprehensive market sentiment indicator. It consists of the 1) CBOE put-to-call ratio, which is currently neutral; 2) the American Association of Individual Investors Bull ratio, which is bullish; 3) the Investors Intelligence Bullish Ratios, which is neutral; 4) the National Association of Active Investment Managers Survey of Manager Sentiment, which reflects extreme optimism; 5) the NYSE New High to New Low ratio, which reflects extreme bullishness and 5) the CBOE Volatility Index, which is neutral relative to long run averages.
According to RBC’s aggregation of the sentiment readings, the stock markets reflect extreme optimism.
Photo: RBC Capital Markets