"People are habitually guided by the rear-view mirror and for the most part, by the vistas immediately behind them."
- Warren Buffett
Humans tend to anchor on the recent past and then project it into the distant future. This occurs in both good times and bad times. As it turns out, there is a name for this type of behavior. It's called "recency bias."
In effect, recency bias gives greater importance to the most recent memories. In the stock market game, this cognitive bias can manifest itself in many ways. For example, an investor could believe that the Fed is always ready to combat declining stock prices with the so called "Fed Put", so stocks will always go up. Conversely, after a severe dislocation in the market, investors may start to believe stocks will never go up and thus sit in cash for an extended period.
There are a number of interesting studies that explore recency bias in investing. In a 2011 study from the Haas Business School at Berkeley, the authors narrowed in on recency bias based on a study of individual investor trading decisions at two large discount brokers. Specifically,
“ . . . the investments bought by investors outperformed the market by 40% percentage points over the two years prior to their purchase.”
So, investors were chasing performance based on how the stocks had done over the prior years. Unfortunately, the strategy didn’t work out so well for investors as the stocks they sold outperformed the ones they bought with strong recent performance.
The important consideration for us is whether the recent memory of investors is more biased to the prior two years when most risk assets went straight up from their pandemic lows (and then some!). Or, conversely are they more biased by the dramatic YTD sell off, with risk assets like the QQQs -26% YTD and Bitcoin -36%?
Positioning can give us a little bit of insight into this question.
Back to the Global Macro Grind…
As a gauge for positioning, we like to look at CFTC positioning to get a sense for investor extremes. Consider the data from the most recent week:
- SPX (Index and E-Mini) is currently +126,198 net long, which is a +1.15X 3-Year Z-Score net long;
- Nasdaq is currently +10,597 contracts net long, which is a -0.01X 3-Year Z-Score; and
- Russell 2000 is currently -71,106 contracts short, which is a -1.57X 3-Year Z-Score.
Simplistically, positioning is a bit mixed. SPX is long, Nasdaq is neutral, and Russell 2000 is short. But none of the indices are at an extreme level of positioning, especially the SPX and Nasdaq where the three-year minimum in positioning is -333,489 contracts and -133,005 contracts, respectively. It is never easier to gauge the sentiment of investors, but positioning can be a tell.
Another measure to look at is ETF inflows. So are investors still willing to buy into the market? In the YTD, we have had some $203BN in inflows, which is admittedly down from last year’s record of $356BN. But, if the current inflows continue, 2022 will be the second largest year of ETF inflows on record. That doesn’t exactly seem like capitulation.
Back in the land of global macro data, the most interesting news as of late has come from China. Consider some of these recent data points from China over the last week:
- April Industrial Production down -2.9% Y/Y, versus +5.0% in March;
- April Retail Sales were down -11.1% Y/Y, versus -3.5% in March;
- April unemployment up to a new post pandemic high of +6.1%; and
- Apparent Oil Demand -6.7% Y/Y in April, YTD Home Sales -32%, Manufacturing Output -4.6%.
Not a lot of good news to see here. Then again, the Shanghai Composite peaked in February 2021 and is only up 10 bps over the last 5-years. The FXI, which is China large-Cap ETF, has been a disaster and is down some -25% over 5-years, down -43% from its February 2001 peak, and now below the lows of the pandemic. So, some of the bad economic data is presumably priced in.
While Keith has recently noted the signal on China stocks is starting to look more interesting, we aren’t there yet on recommending it as an allocation. But there is certainly a unique divergence versus the U.S. and Europe.
China’s economic data is downright recessionary, while in the West we are seeing slowing but not contraction. The West is tightening, while China is easing monetary policy. Meanwhile, it’s also been many years since anyone has made money in large cap China stocks . . .
But as Reid Hoffman famously said:
“It’s actually pretty easy to be contrarian. It’s hard to be contrarian and right.”
Indeed.
Immediate-term Risk Range™ Signal with @Hedgeye TREND signal in brackets:
UST 10yr Yield 2.78-3.14% (bullish)
UST 2yr Yield 2.53-2.76% (bullish)
High Yield (HYG) 75.51-78.35 (bearish)
SPX 3 (bearish)
NASDAQ 10,821-12,528 (bearish)
RUT 1 (bearish)
Tech (XLK) 127-141 (bearish)
Utilities (XLU) 70.15-72.82 (bullish)
Shanghai Comp 2 (bearish)
Nikkei 25,701-26,818 (bearish)
DAX 13,318-14,212 (bearish)
VIX 26.01-36.49 (bullish)
USD 102.67-105.25 (bullish)
EUR/USD 1.035-1.064 (bearish)
USD/YEN 127.91-131.27 (bullish)
Oil (WTI) 99.36-115.43 (bullish)
Nat Gas 6.96-8.95 (bullish)
Gold 1 (bullish)
Copper 4.05-4.36 (bearish)
Keep your head up and stick on the ice,
Daryl G. Jones
Director of Research
