What’s Next for Hard-hit Investor Sentiment?

Investor SentimentBelow 1,200 on the S&P 500 Index, the stock market will have returned to its correction trading range it experienced from August to mid-October. Recent trading action in the broader market has been nothing short of terrible.

Declining investor sentiment since the eurozone summit on the debt crisis is the catalyst for the stock market’s recent trading action—a market that’s actually gone down on some good news. This is always a sign that the bears are in charge.

What the stock market and commodity markets are experiencing is the continued lack of certainty in the global economic playing field. With no real trends emerging in economic data or from policymakers, institutional investors have been running to the sidelines once again. Against this backdrop, investor sentiment can’t really do anything but drift into malaise.
The uncertainty remains a very serious risk for global investors. The eurozone could equally stabilize or fall apart completely. The U.S. housing market could show some improvement in the first half of 2012, or home prices could accelerate their decline. All scenarios are possible in the current environment and this is why investor sentiment has been hit so hard lately. Without relative certainty in the marketplace, the main indices are drifting.

Playing this kind of market is extremely difficult. In any stock market, there are always event-driven trades, with some companies announcing good news and others doing the opposite. The key in this kind of market is to use declining investor sentiment to your advantage and this means identifying the companies you would like to own in advance, while waiting for an attractive price point at which to buy. This is the best play in this kind of stock market and it’s mostly with larger-cap, higher dividend paying stocks.

There still is no reason for any new, bold action with investor sentiment being so lackluster. With declining expectations for GDP growth and corporate earnings, the stock market seems increasingly likely to drift into the New Year. It wouldn’t surprise me if the Federal Reserve were to announce some kind of new monetary policy action, and the stock market almost always reacts positively to such events. Still, I think we haven’t yet seen the worst of the trading action. The stock market could easily test the bottom end of its recent correction trading range. (See How Stocks Are Reflecting the Structural Excesses of the World.)

Domestic investor sentiment is still being held hostage by the eurozone’s debt crisis. It can turn positive, but will require a stream of positive economic data in order to do so. I’ll be impressed if the S&P 500 Index can stay above the 1,200 level, but I don’t expect investor sentiment to change in the near future. If the S&P holds 1,200, it could be a new base for the index, but I wouldn’t cross any fingers.