The Seesaw of Investor Sentiment

The Seesaw of Investor SentimentInvestor sentiment seems to change on a dime these days; it’s part of the stock market’s continuing fragility and uncertainty regarding the future. One day, share prices move higher based on perceived new confidence; the next day, an event or news item pulls prices lower.

In spite of the volatility in investor sentiment, the general price trend has been mostly higher since mid-December. The stock market is seemingly off to a good start this year, but no one knows how things will end up. (See The Only Catalyst That Will Move This Market—It Isn’t the Fed.)

The systematic risk in the financial system remains due to the European debt crisis and this will continue to be a major potential shock that could take hold at any time. A Greek sovereign debt default would actually be a very small event dollar-wise, but it would be symbolically significant and a short-term blow to investor sentiment. Knowing this, stock market investors have grown somewhat tired of the issue, and institutions are now content to deal with fourth-quarter earnings season.

If corporate earnings and visibility hold up, then I think the stock market has good potential for a double-digit gain this year. Especially when it comes to investor sentiment, financial markets experience waves of enthusiasm and, after a tough year in 2011, there is an appetite in both the U.S. and European markets for equities. At the end of the day, not much else pays in a world with such low interest rates.

China’s economic news flow is now entrenched in domestic capital markets and it does affect global investor sentiment. That country’s news on inflation, interest rates, housing prices, and GDP growth represents important, actionable data that move the U.S. stock market. Times are changing quickly and, from my perspective, it really is a new era when a country like China affects domestic investor sentiment and the stock market. The world just keeps getting smaller.

I would really like to see the S&P 500 Index break and hold above the 1,300 level. Investor sentiment is good enough right now. If the stock market can do this, then I think we have the makings of a solid new base, at least for the first half of the year. Earnings expectations have come down for 2012, but corporations are still sitting on piles of cash with improving balance sheets. You could argue that U.S. large-cap companies have never been healthier. They’ve had to deal with so many shocks in recent years that most are running their operations about as lean as they can be. With the exception of the big banks (which did it themselves), corporations are, for the most part, very well positioned for the future. The stock market isn’t necessarily, but companies are.

If we are going to get a sustainable new base for the stock market, then investor sentiment will have to be buoyed by a combination of improving economic news, solid corporate earnings, and stability in the eurozone. I suppose that’s a lot for an investor to ask for, but, then again, we’ve been dealing with a lot of shocks lately. We’re due for a little calm, at least before the next storm hits.