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0 Jan 13 2011 @ 10:58am by Matt Smith in Capital Markets, Crude Oil, Economy

The Best Things In Life Aren’t Things

Flipping through a book on graffiti in the past week, I came across this phrase and image. It set me off on the tangent that the best things (= most bullish influences) in current markets at the moment are not ‘things’ (i.e. underlying fundamentals), but the unquantifiable: perception and sentiment.

The mighty David Rosenberg (aka Batman) said last year that ‘the equity market at any given moment in time is one part reality to three parts perception’. In this report on equity markets from RMG Wealth Management, it highlights the extent of current optimism. Measured by a weekly poll, bullish sentiment among individual investors for US equities is at its highest level in nearly six years: 

This could be interpreted that equities are going to keep moving higher because confidence in markets is very strong. However, the reality is that such an extreme level of bullish sentiment should be viewed with caution, as markets tend to reverse when optimism reaches extremeties.

Next the spotlight swings to our dearly beloved commodity of crude oil. The CFTC (Commodity Futures Trading Commission) releases a weekly report called the Commitment of Traders, which identifies the positions taken by traders in the futures and options markets of commodities such as crude oil. The interesting point here is that long positions held by non-commercials (i.e. financial traders such as hedge funds) have increased to near all-time record levels (see below). This indicates that speculators are positioned to benefit should prices rise. From this perspective, it is understandable why $100 oil seems like a foregone conclusion. That said, such an extreme number of long positions should raise concerns, just as the bullish sentiment should for equities above.  

CFTC Crude Oil Non-Commercial Long Contracts (futures and options)

Third and finally, I want to highlight sentiment in itself. The Thomson Reuters / University of Michigan Sentiment Index is one of the most widely followed sentiment indices in the US. Its predictive nature is such that the US Department of Commerce uses its data as an input into its own economic analysis. The goal of the index is to ultimately measure the prospects for the US economy through the level of optimism / pessimism in the US consumer. 

This index highlights a similar trend that we currently see across many different economic indicators – from industrial production to employment. And it is this: although conditions are improving and we are in better shape than where we were back in 2008,  we are still not back to pre-recessionary levels – for industrial production, employment…..or sentiment: 

Thomson Reuters / University of Michigan Sentiment Index

The point of all of this is to highlight that perception and sentiment play a large part in financial markets. And as markets start 2011 full of hope, we have to be wary of ‘irrational exuberance’, but at the same time not ignore the reality: that ‘things’ may actually be getting better.

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