Think Outside the Box!

Please note this blog post was published over 12 months ago and so may not include the most up-to-date information, for example where regulation around investing has changed.

Think Outside the Box!

Psychology plays a large role on investment decision taking. Thus ‘sentiment’ impacts the prices of assets, particularly in the short term. In very simple investor speak, if asset prices are inflating it indicates bullish sentiment; the opposite termed bearish sentiment.

One danger associated with markets being unduly influenced by emotions and sentiment is that prices can depart, often meaningfully, from their fundamental characteristics. Another expression used for fundamental characteristics is intrinsic value, a term used by Benjamin Graham the so-called father of investing.

Smart investors, particularly those following momentum, spend a lot of time studying sentiment, looking for technical signals to help them gain an edge. Contrarian investors look to take advantage of these short-term trends exploiting over and under valuation opportunities.

Multiple factors lie behind shifts in sentiments: Examples include over exaggerated fears or hopes and even fears about market volatility itself. The tendency to exaggerate can be applied in many different settings – monetary policy, geopolitics, interest rate setting etc.

Sentiment Indicators

Source: Bloomberg, January 2019

The chart above contains a variety of sentiment indicators. At first glance, without going into any detail, wild swings are immediately obvious. However, if you focus on the lines to the right, from late 2017/early 2018, sentiment started to drop. This is perhaps not too surprising given the many uncertain geopolitical events unfolding throughout last year.

Sentiment however, isn’t always the most reliable indicator. For example, in the UK around the time of the Brexit referendum result, consumer confidence collapsed, but the share prices of mid-sized companies, represented by the FTSE 250 index, bounced back even though they have a clear domestic focus. In other words, sentiment soured but was ignored by investors focusing on what was actually happening. We now know the economy did not collapse as many feared at the time.

UK Consumer Sentiment vs FTSE 250 Performance

Source: Bloomberg, January 2019

As we fast forward from the point of collapse in consumer confidence over the Brexit result we can see that sentiment has improved. It hasn’t returned to previous highs, and is still sluggish and in negative territory, but we can hardly be surprised given the media onslaught about potential food shortages and higher prices emanating from the ‘no deal’ Brexit debate.

What about UK economic fundamentals- what are they telling us today?

Fundamental Economic Measures

Source: Bloomberg, January 2019

Growth in the UK is trending a little lower and inflation a little higher compared to other developed economies, however not remotely as bad as the forecast provided by the Bank of England when they implemented an emergency rate cut in the aftermath of the result. Were they responding to exaggerated fears? Probably. We know that the emergency cut wasn’t needed because it was reversed. Interest rates remain low but at least they are not on the floor as in Europe where emergency monetary policy measures are still needed. In the UK low unemployment is the major bright spot particularly when compared to Europe.

In conclusion, sentiment can be measured through various indices. The outcomes shown capture emotions that can be exaggerated but resonate with the mood at the time.

With investing, your capital is at risk. Investments can fluctuate in value and you may get back less than you invest. Past performance is not a guide to future performance. Tax rules can change at any time. This blog is not personal financial advice.

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