Extremes of sentiment in markets

Towards the end of last year, I published a series of short posts on what I saw as a newly emergent but potentially powerful trend in financial markets, in which sentiment seemed to overshadow analysis and fundamentals as a driving force. In light of recent eventsthat is, the surging stock price of GameStop and related others, the explosive influence of retail traders and the message boards where many converge, and the observed ripple effects into other parts of the investment worldI am combining the original articles into a longer essay, edited for consistency and to eliminate redundancies between them. Some things happen gradually, then of a sudden… We saw the sudden that unfolded the past week, this is about the preceding gradual.

The most basic fundamental

Financial markets are sentiment markets in large part, even as we feign to strip out the emotion from the buy or sell decision. It is a matter of degree, perhaps, and self-control, to stick with data, the practiced formula and its principles, the so-called fundamentals that are taught. Yet in so doing — rigidly, consistently, like a machine — one makes a statement on a view, and by contrast on the others that may not coincide. That isn’t something lacking in emotion, truth be told, not altogether. There’s really no escaping it.

Institutional Investor
Investopedia
  • The evaluation now may be as much financial as it is psychological, cultural, and social; that is, the exercise is as much now predictive of cash flows next quarter, or next year, as it is to predict prevailing sentiment during that period.
  • Sentiment (the reaction to new (or older) information, more than the information itself) leads to where capital quickly follows. The future bank, perhaps, will be a media conglomerate. No, it already really is.
  • There is entertainment in investment, as there is entertainment in consumption, and one may recognize this sentimental factor before the placing of a trade.
  • Sentiment can be contagious; the market is, by definition, right.
The Hustle

The biggest risk

Our favored valuation multiples have over time climbed up the income statement ladder, rung by rung, and, before long, we may transcend the income statement altogether.

Ticker: SQ

The third body

In short, the current market context calls for a new look at drivers and parameters, established during times and markets that reflected greater structure, or a structure that was maybe more conducive to methodical assessment.

Forbes
WSJ
Bloomberg
TechCrunch

The sentimental vista

There are any number of ways to define, or interpret, sentiment. This can depend on context. For financial markets, which are multivariate and deep, the context and its drivers, the resulting definitions and interpretations, are like a mosaic — personal, social, geographical, political, historical, economic, industrial, educational, speculative — but it’s all speculative, really. The markets are a network system in which clusters form or dissipate, to build or shrink the sentiment of an idea in its time.

  • Sectors and established categories, small caps and large caps, growth and value, are increasingly dubious distinctions outside of sentiment, which can have reflexive consequences; and the rotations, ups and downs of these, throughout the year that’s passed, have set the tone of movements going forward.
  • Price action and market trends in many cases have been and will be justified by finance fundamentals — after the fact — as anything can be when there’s a will and a creative spirit, when sentiment is in actuality the driver; to draw general conclusions from the particular case will thus require caution.
  • All this poses special challenges for investors, some previously alluded to: (1) Sentiment is difficult to forecast. (2) Spotty, often capricious, and uneven, sentiment is difficult to hedge. (3) Sentimental correlations are unstable, and so portfolio construction becomes inordinately problematic.
  • Spilling over from the elements above, alternative new markets have come into their own, where price has been and always will be built on sentiment unabashedly; for instance, art, collectibles, and other assets where financial metrics play no role at all.
  • One such alternative new market, which has already started to explode, individually for the first few years but now also institutionally, is cryptocurrency; the explosion is likely to continue, driven by sentiment.
  • The most successful investors will be successful at anticipating market sentiment (and its changes) during an investment period; by necessity, therefore, investment periods will shorten at one end of the barbell, where change in sentiment is easier to grasp, and lengthen at the other end, where sentiment, over the long run, is more likely to settle down and meet with fundamentals on a common ground.
  • Over the course of time, the markets (which are always right) will incorporate the acts, extremes and fickle patterns of sentiment into an analytic system, to expand upon legacy methods of financial evaluation and economic forecast; this may not happen as quickly as this year or next, considering the dense complexity that underlies.

In an economy that can’t be trusted

When an economy is understood, up or down, it’s possible to plan, to concentrate resources, and to invest with reasonable confidence, even if results don’t follow as expected. If the previous section presented its thesis from the institutional perspective, more or less, what follows is a market thesis from that of the retail trade, in an economy that isn’t understood, and can’t be trusted.

  • In 2020, so much of the economy was rendered worthless. Often permanently. On a dime… for reasons unrelated to the individual’s affairs. This was unprecedented, it is said, both in its magnitude and unexpectedness. And it has naturally left a deep impression.
  • The active retail trade that drove the market in this time was, in this way of seeing things, a sort of panic. Its flight was to liquidity, to diversification, to the hedge — those things, in other words, which are the opposite of what the natural economy presents to many — as economic plans took such an awful turn for such large numbers.
WSJ
Barron’s
FT
  • … and because sentiment is different and more complex than earnings, which furthermore are not, like sentiment, contagious…
  • … and because sentiment, much more than earnings, is prone to unexpected change…
  • … and because sentiment may not be market-wide, but picks its spots, or fades from them, in isolated clusters in the market network mesh.
CNBC

Investment, finance, strategy, execution in the networked tech economy. https://www.linkedin.com/in/danramsden

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