Institutions Start Heading for the Exits

December 12, 2022 | Are institutions turning bearish? Allio’s Chief Investment Officer, Raymond Micaletti , discusses the current relative sentiment and what investors should be looking for this week.

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This week we will get two major pieces of information—the November CPI report and the FOMC rate decision (and outlook). Everything else will likely take a backseat to those two events.

Last week we noted institutions were positioned for a soft landing—being generally bullish on liquidity- and growth-related assets. We also mentioned the window of time for those conditions to play out might not be open-ended.?

Indeed, this week our positions-based relative sentiment indicator, which measures how institutions are positioned in equities, long-duration bonds, and along the yield curve, will turn bearish. It will be its first bearish reading since late June.

This bearish turn does not necessarily mean equities will immediately roll over (though they certainly could). In the past, we have observed institutions tend to turn bearish a bit early.?

For example, this indicator turned bearish on equities in July of 2021—the U.S. equity market did not peak until November of that year (five months later). Similarly, the indicator turned bearish on equities in early August 2018, while the market did not peak until late September (six to seven weeks later).

This indicator is not the only one flashing red, however.?

Macro retail sentiment has also taken a bearish turn. Commodities sentiment has breached a zone that suggests the market is worried about growth or deflation. When this occurs, it typically acts as a headwind for equities.?

Further, while dollar relative sentiment is comfortably bearish—and that tends to be bullish for a variety of assets and market relationships (e.g., equities, gold, real rates, credit spreads, the yield curve)—last week, speculators bought the dollar relative to retail traders. This buy spike was not out of the ordinary, but it bears watching as it may be the start of a dollar reversal.?

Recall that speculators began selling the dollar in August as the dollar was approaching its peak (it peaked in September).

Thus, symmetrically, we may be in the initial phases of speculators buying the dollar, which might suggest the dollar is in the midst of forming a bottom.?

Despite those bearish undercurrents, the way investors are positioned in the dollar, the euro, the Eurodollar, the 2-year Bond, natural gas, and copper all suggest favorable conditions for equities and other risk assets.?

One asset that looks poised to benefit regardless of how things shake out is gold. Gold tends to do well when dollar relative sentiment is bearish and real rates are falling—both happen to be true at present.?

Gold also tends to do well when equity relative sentiment is bearish—while equity relative sentiment is currently bullish, it has the potential to turn bearish in the next week or two.?

Thus, gold has two potential paths to bullish conditions—bearish dollar action or bearish equity action.?

The fact equities have sold off leading up to this week is encouraging, as it increases the odds, however slightly, that equities could bounce even if the CPI numbers are slightly higher than expected—if, for example, the underlying components show favorable trends.?

But in general, we would expect equities to sell off if the CPI number is undeniably hotter than expected, as the Fed would likely have to be more hawkish the following day. This could potentially lead to a retest of the October equity lows and worse.?

Whereas if CPI comes in cooler than expected, it’s plausible equities could finally push through the resistance they have struggled with since running headlong into it after the last CPI report.?

This latter scenario would be most compatible with the current investor positioning. It would allow for additional upside in risk assets and give institutions, who appear to be positioning themselves for an eventual resumption of the market’s downtrend, ample trading volume to sell into.?

Given the resolution this week is likely to bring, there’s no reason to speculate more than we already have. Let’s see what happens.?

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