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Good Kitty or bad Kitty?

Good morning. By Thursday, we are all likely to feel differently about the state of the economy and the outlook for markets than we do right now. The biggest reason is that we have a consumer price index inflation report on Wednesday. But that is not the only reason. Today, we have Home Depot earnings, and Walmart comes Thursday — two of the most important corporate barometers of the US consumer. Throw in Jay Powell speaking in Amsterdam today, producer prices, retail sales, and housing starts, and you have an information-rich week. Send your predictions to: robert.armstrong@ft.com.

Meow, and other sentiment gauges

Roaring Kitty, also known as Keith Gill, tweeted a picture of a man leaning forward on Sunday night. Gill had a lot to do with the impressive, amusing, and irrational run-up in GameStop and other meme stocks in 2021. There was a quite good if basically deceptive film about him last year. He had more or less disappeared until Sunday. And so, naturally, GameStop shares were up 75 per cent, or about $4bn, yesterday. Other meme stocks (AMC, BlackBerry, et al) went bananas, too.

Obviously this is a very stupid thing to happen, but the stock market is full of very stupid things which active investors have little choice but to pay attention to.

The first thing to say is that while yesterday’s move in GameStop is stupid — in a world full of approximately rational people, the meme stock saga never would have even gotten started — it still makes sense, in the sense of being explicable. Gill and his retail army moved stocks before. They could perfectly well do it again. Almost a third of GameStop’s shares were sold short before the Gill tweet, so there was probably a huge short squeeze that explains a lot of the upward move, and short squeezes are normal, well-understood stock market happenings. (Though it should be said that joining a crowded short position in a smallish stock that is famous for squeezing out shorts, and which is a known plaything of sentiment, is an enormously stupid thing in itself. Why would someone do this? Did they not see the movie?).

The second thing to say, or rather to ask, is whether the extreme reaction to what might or might not be the return of Roaring Kitty (suppose someone just hacked his account?) reflects about market sentiment. Are we back in summer 2021-style euphoria?

The answer seems to be: no, but we are not a million miles away.

Unhedged’s favourite blended measure of sentiment, Citi’s Levkovich index, incorporates a bunch of stuff such as the margin debt, the put/call ratio, and short interest. It remains well below the glue-huffing levels of 2021, but it is not far short of the level Citi designates as euphoric. Citi’s chart:

Levkovich index

Turning to individual investor sentiment, below is the American Association of Individual Investors survey (which is one component of the Levkovich). The weekly reading has come off of recent highs, but looking at the smoothed three-month average, we are about as high as the measure has gotten in the past few decades.

Line chart of AAII Investor Sentiment Survey, bull-bear spread % showing Feelings. Nothing more than feelings.

The strong sentiment might concern me more if the market, other than yesterday’s meme stock revival, was acting otherwise crazy. But, while valuations and prices are uncomfortably high, signs of insanity are hard to come by. Utilities do not outperform in totally crazy markets, as they have in the past three months. Of the big artificial intelligence-hype stocks, only Nvidia is crushing the market. Microsoft, Google and Amazon are performing merely solidly this year.

Another interesting counterpoint is consumer (as opposed to investor) sentiment. It has never recovered from the pandemic, and while it was trending up recently, it took a dive in May for reasons that are unclear — petrol prices are trending down, the stock market is OK, and inflation hasn’t gotten suddenly worse in the last month. Commentators are pointing to a mishmash of causes: war in the Middle East, campus protests, cows with bird flu, and so on.

Line chart of University of Michigan consumer sentiment index showing In a sentimental mood

The decline could just be noise. But assume it’s not. It would be slightly odd if we entered into a euphoric period for markets while consumers were down in the dumps (even back in 2021, when Roaring Kitty was last in his pomp, consumer sentiment was on the rise). It would be nice if cultural malaise was, if nothing else, a prophylactic against irrational exuberance in markets.

Corporate bonds versus government bonds

If you were looking for signs of insanity in the market, you might try looking at corporate bonds. Here is a chart from Michael Hartnett’s team at Bank of America. It is the ratio of total return indices for US triple A corporate bonds and long-dated Treasuries. Holy crow:

Chart of corporate and government bonds performance

Corporates’ outperformance of Treasuries since the early days of the pandemic is uninterrupted and historically unprecedented. Hartnett calls it the “long corporations, short government” trade. One might be tempted to frame this in terms of declining sovereign credit quality, as US deficits explode, while the balance sheets of the strongest US companies grow ever stronger. The idea of that framing would be that, in a worst-case scenario, the spread between riskless but over-issued Treasuries and scarce high-quality corporate bonds could disappear or even go negative.

Another, less-apocalyptic explanation of investment-grade spreads is simple demand. The return of Treasury yields that are quite high in both nominal and real terms has led to a surge in investor flows into fixed income generally. And there is a powerful logic for picking up a few extra basis points of yield (less than 40, at present, for triple A bonds) by buying corporates rather than Treasuries. The tight spreads will only widen meaningfully if recession risk — which now feels very remote — rises. And if that happens, interest rates will probably fall, offsetting the pain from wider spreads. Of course there are ways the trade could go wrong (stagflation, anyone?). But the bond market only sees one thing right now: all-in yields on corporate bonds that are higher than they have been in a long, long time.

One good read

More babies please.

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