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Our views 29 May 2024

ClockWise: Sentiment signal successful again but is the rally now over?

5 min read

In late April, we pointed to the increased levels of volatility which had come alongside equities experiencing their worst losing streak since last October and highlighted the fact that our Composite Sentiment Indicator had moved into depressed territory.

A depressed sentiment score on our weekly sentiment model, in our view, means that equity markets have become oversold and that investors have become too nervous. This is a positive signal for equities.   

In the weeks following our sentiment indicator recording an oversold reading, equities have rebounded around 7%, with the S&P 500 having advanced for five consecutive weeks (Chart 1). This rebound in markets has not come as too much of a surprise to us, as a stock market recovery from low sentiment levels is almost about as inevitable as Manchester City winning the Premier League. In fact, using the last 30 years of data, our research shows that when our sentiment indicator moved to oversold levels, equity markets have recovered on average 2.9% in the following five weeks. This is almost three times higher than the overall historical average four-week stocks return over the same period of 1.1% (although note that past performance is not a guide to future performance).

Chart 1: RLAM Composite Sentiment Indicator

Chart shows RLAM Composite Sentiment Indicator

Source: LSEG Datastream as at 24/05/2024

Equity markets have been supported over recent weeks by a fading of geopolitical risk and strong corporate earnings. Earnings beats have been well above average in the US, Japan and Europe. Strong corporate earnings upgrades are common when macro support is present. There has been an improvement in our nominal growth scorecard in recent quarters (Chart 2) as well as improvements in the global composite Purchasing Manager Index business survey since Autumn 2023. In that context, we are not too surprised to see equity market returns being backed by corporate earnings.

Last week was a further demonstration of this, as we heard from the tech heavyweight Nvidia. The company showcased yet another quarter of exceptional corporate performance and released guidance that once again beat analysts’ expectations. This saw the technology sector outperform sharply over the week and sent both the ‘Magnificent 7’ index and Nasdaq to new record highs.

The sentiment-fuelled rally has seen markets move up to fresh highs. However, with markets at these levels and corporate earnings season now behind us, investors are questioning where stocks go from here. The main catalyst may be policy. Signs of resilience in economic data have not been fully welcomed in recent sessions. For example, improvements in business surveys last week were a key driver as investors moved to price in less interest rate cuts from central banks this year. There is concern that equity markets will fall from their highs if central banks underdeliver on expected rate cuts for the year.

However, strong underlying macro conditions should be supportive for company earnings. So, if a delay of rate cuts is caused by strong growth, it may not necessarily be bad for equities. We continue to monitor how the economic landscape feeds into market expectations and remain vigilant to react as needed.

Chart 2: EPS Revisions and RLAM Nominal Growth Scorecard

Chart shows EPS Revisions and RLAM Nominal Growth Scorecard

Source: LSEG Datastream as at 16/05/2024


This is a financial promotion and is not investment advice. Past performance is not a guide to future performance. The value of investments and any income from them may go down as well as up and is not guaranteed. Investors may not get back the amount invested. Portfolio characteristics and holdings are subject to change without notice. The views expressed are those of the author at the date of publication unless otherwise indicated, which are subject to change, and is not investment advice.