This week, Bank of America released my favourite sentiment survey. It’s the monthly survey of what global fund managers are buying, selling, and thinking.
It’s useful because it gives you an idea of where the world’s money managers are putting their cash. You’ll often find that you can profit by doing the exact opposite.
Why sentiment matters to markets
Sentiment is a hard thing to gauge in the stockmarket. There are lots of different “bull vs bear” measures and it’s not always clear that any of them tell you that much. It’s probably worth thinking about why we care in the first place.
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In the long run, asset prices should (we hope) be driven primarily by fundamentals: If you buy a company with good prospects at a reasonable price then it should turn out well for you. That’s the point of markets – they are the best pricing mechanism we have, which makes them the best way to allocate resources effectively.
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In the shorter run though, asset prices are driven by money flows. If everyone decides to buy bitcoin, say, and there aren’t many bitcoins to buy, then the price will go up, regardless of the fundamentals.
And the reality is that markets don’t always focus on the long run in a sober and sensible manner. We’re all human, we all want to get rich quick (even those of us who know it’s a bad idea to think like that), and we’ll all chase a hot trend.
So, for want of a better word, “feelings” matter. Sometimes we let them get away with us. And in the stockmarket, that translates into assets being mispriced – either well above what they “should” be, or well below.
The question is: how can we tell when investors are being overly excited or gloomy about a particular sector or market? That’s where sentiment comes in. You’re trying to capture the “mood” of the market to get a better idea of where the best opportunities might be.
The next question is: how do you measure it? There are lots of different ways, most of them more art than science. One of my favourites on the “art” side (though it’s really quite reliable) is the magazine cover indicator. This is the idea that an investment trend has probably run its course by the time it’s appearing on the covers of widely-read, general interest magazines.
It’s not because there’s anything wrong with the quality of reporting in these magazines, it’s the fact that once a trend gets big enough to escape the finance pages and land on the front of newspapers or generalist magazines, it means that there can’t be many people who are yet to hear about it.
In turn, that means the pool of buyers must be drying up. And that suggests a turn might be coming. (It’s the same for negative stories too – if you’re reading about the end of oil everywhere, it’s quite likely that the oil price is nearer a low than a high, for example.)
Anyway – that’s why I like to pay attention to sentiment. And the monthly global fund manager survey is another useful one.
Put simply, these people control the big money flows. If they’re all very bullish or very bearish on one area, that probably means it’s close to an extreme, simply because there’s no one left to add weight to that particular position.
Investors are getting more relaxed – or complacent – about inflation
So what stands out from this latest survey?
The first thing is that it’s very “August”: there isn’t a clear message from this month’s survey. There is not a lot of conviction about anything much. Managers are getting a bit gloomier about growth prospects and seem to think that the reflation trade has run its course, but they’re not massively bearish.
So there are no obvious “extreme” positions here. That’s worth noting; when it comes to sentiment and contrarian bets, you’re not looking for situations where 60% think one thing and 40% are on the other side. You’re looking for 90/10, or 99/1 splits ideally – really lopsided opinions, which mean that your downside is tiny relative to your upside.
What about stories that might be worth watching?
The main one that stands out is that investors already seem to be “over” inflation. In April, more than 90% thought that inflation would be higher than current levels in 2022 – now that’s down to just 4%. Other than during the pandemic, that’s one of the lowest readings seen since around 2012.
I think it’ll take a while to convince investors that inflation is a longer-term problem, but the fact that they’re already discounting it suggests there could be some surprises in the second half of the year.
Just one final thing to flag up on the contrarian thinking point – this survey was taken before the collapse of Afghanistan. And the reading shows that fund managers were notably complacent about geopolitical risk, relative to the history of the survey.
Given the explosion of instant expert articles trying to read across to Taiwan in particular, I suspect that’ll have changed by the time the next survey comes out next month.
But it’s a valuable lesson – as an investor, it pays to keep your eyes on what everyone else is ignoring. Just in case.
(If you’re interested in contrarianism, I wrote a book, The Sceptical Investor, about it a couple of years ago – it’s still very relevant, even if I do say so myself – you can buy it here).
