Financial markets have always been a curious mix of logic and emotion. Investors like to tell themselves, and each other, that they make decisions rationally, with cool heads and spreadsheets in hand. Sentiment, however, is a powerful driving force.
The driving force of market psychology
Spend time in investing circles and you’ll feel the pulse of the crowd as it bobs between fear, greed, hope, and panic. These feelings push prices higher or lower, often without any logical drivers. While fundamentals such as earnings, cash flows, and balance sheets – are supposed to anchor asset valuations, the last decade has demonstrated that sentiment can be a stormy wind, blowing prices far from their “rational” moorings.
Have markets broken away from fundamentals?
There is growing evidence that markets no longer obediently follow the guidance of corporate profits or macroeconomic data. In fact, the disconnect between market valuations and underlying fundamentals has become one of the most talked-about topics among professionals and retail investors alike. Consider the periods following the pandemic crash: Tech stocks rocketed to all-time highs at a pace that seemed completely divorced from their earnings outlooks or even their own forecasts. Many tech companies saw wild price increases long before their businesses grew to justify even a fraction of those valuations.
This growing gap is not merely anecdotal. Multiple studies and industry commentaries suggest that price-to-earnings ratios, for many key indices, have reached levels historically associated with bubbles. There have been periods when markets continued to rise despite weak GDP numbers, high unemployment, and escalating geopolitical risks. Even seasoned institutional players sometimes shake their heads in disbelief at how distant equity prices have grown from traditional measures of value.
So, what does this mean? Has the market peaked into a new dimension, where fundamentals are but a distant memory? Not exactly. Instead, it may simply reflect those whose voices are loudest, and what emotional tone – hopeful, fearful, greedy, or euphoric – dominates the conversation.
The sentiment engine: What’s driving markets today?
Several powerful influences have converged to turbocharge sentiment and allow markets, at times, to float freely above the bedrock of fundamentals.
- The information tsunami
Never in history have investors had so much data – real, dubious or categorically false – instantly available on their screens. News, Tweets, regulatory filings, and earnings calls appear with lightning speed. This information – flow fuels the rapid formation and reversal of narratives. A single influential voice, or a viral meme or social media post, can galvanise millions of investors to buy, sell, or hold, creating self-reinforcing price trends untethered from company realities.
- The rise of the retail investor community
Traditionally, institutional investors set the tone in markets. But recent years have seen a spectacular surge in retail participation, most dramatically through low-cost, zero-commission trading apps. Online communities organise “buy-the-dip” strategies, turn companies into cult stocks, or engineer short squeezes with meme-level enthusiasm. Their motives aren’t always strictly financial, and their collective action can overwhelm any attempt at valuation-driven pricing.
- Algorithmic and passive flows
The market structure itself has changed. Algorithms now dominate order flow, not always responding to fundamentals but rather to patterns, trends, or even the actions of other computers. Likewise, the explosive growth of passive investing means trillions flow into stocks simply because they are in an index, fuelling a relentless price drive that is divorced from company performance.
Opportunity… and Danger
If market prices can so easily part ways with fundamentals, how should investors navigate an environment ruled by sentiment?
This environment creates a massive opportunity: Those who understand and anticipate the mood of the market can ride waves of optimism or batten down the hatches against incoming storms. Tactical traders, momentum players, and short-term opportunists may find rich pickings in rapid sentiment shifts.
But the dangers are equally potent. Sentiment is fickle – a market darling today can be abandoned tomorrow. When the mood turns, prices can fall much faster than reason would suggest, inflicting sudden, outsized losses. Fundamentals may be ignored for a while, but they have a way of eventually reasserting themselves, sometimes abruptly.
The investor’s toolkit: New rules?
- Resilience: Don’t be seduced by frothy narratives, and understand that popularity alone is no guarantee of lasting value.
- Flexibility: Be nimble. Monitor sentiment indicators, social trends, and technical signals in addition to balance sheets and income statements.
- Diversification: When market psychology is erratic, spreading risk is even more critical. Diverse portfolios can help absorb shocks when sentiment reverses.
- Long-term perspective: Remember, time in the market beats timing the market. Over longer periods, fundamentals have a stubborn way of resurfacing and setting the score.
Tempering optimism with scepticism
In today’s markets, the invisible hand of sentiment often moves faster than facts. Prices soar on shared optimism or tumble on viral panic – the 2 April “Liberation Day” equity sell-off is just one of many recent examples. Fundamentals remain vital, but they may operate on a different time frame than trader psychology. For investors, the challenge, and opportunity, lies in recognising when prices are fuelled by feeling rather than fact, and then steering investments accordingly.
It must always be remembered; sooner or later, sentiment always swings back, and reality will always have the last word. Pay heed to the crowd but never lose sight of the underlying story.
A LOOK AT THE MARKETS
This week’s key themes:
- Investors weigh robust US jobs numbers against potential Fed rate moves
- Robust earnings drive Wall Street to fresh highs, while JSE All Share breaches 100,000
- Oil finds reprieve as US-EU trade agreement progresses
- US Dollar Index faces weekly losses as probability of interest rate cuts decline
Bonds
The 10-year United States (US) Treasury yield climbed to 4.45% this week, primarily driven by stronger-than-expected US labour market data. A sixth consecutive drop in jobless claims fuelled views that the US economy remains resilient, diminishing expectations for an imminent economic slowdown. Investors weighed the robust jobs numbers against potential Federal Reserve (Fed) rate moves; futures still price in two cuts this year, but the immediate need for monetary easing has faded. Additionally, progress in US-European Union (EU) tariff negotiations created optimism on the international trade front, lessening risk aversion even as Treasury yields rose. The anticipated extension of the US-China tariff truce also reduced downside risks, supported by official comments signalling likely continuity in trade policy through to, at least, mid-August.
Germany’s 10-year Bund yield edged up to 2.68% after the European Central Bank (ECB) left rates unchanged, following a series of cuts over the last year. The post-meeting statement and ongoing EU-US tariff talks prompted a more cautious approach from investors, who now foresee a less aggressive ECB easing cycle amid ongoing economic uncertainty, particularly regarding trade relations with the United States and recent global volatility. Declining German consumer confidence and softer-than-anticipated business activity data further tempered bond optimism, despite low inflation.
UK Gilt yields moved higher as the Bank of England (BoE) maintained a “wait-and-see” stance. Weaker UK Purchasing Managers Index (PMI) numbers heightened speculation overgrowth woes, though market focus was shaped by improved trade prospects – particularly a newly signed deal with India – and the outperformance of equity markets over bonds.
South Africa’s 10-year yield rose to 9.82% after a quiet week, little changed from previous trading sessions. While yields are down from a month ago, domestic bonds saw muted movement as foreign sentiment stabilised, and local inflation prints remained in line with expectations. Longer-term, SA yields mirror persistent risk premia but have shown resilience amid global trade developments.
Indices
American equities closed at fresh record highs midweek, propelled by robust corporate earnings – notably Alphabet’s positive guidance – and optimism around progress in global trade negotiations. Tesla’s results introduced volatility, but broader sentiment stayed positive as both US-EU trade talks and the US-China tariff outlook provided clarity. The Dow Jones lagged slightly due to sector rotation but remained up on the week.
The UK’s FTSE 100 surged 0.9% to a record 9,138, outperforming its European peers. Gains were fuelled by a landmark trade deal with India, upbeat corporate earnings, and a weaker pound. Manufacturing data exceeded expectations, offsetting the drag from weaker services and composite PMIs.
Germany’s DAX advanced modestly, buoyed by strong second-quarter results at financial services firm, Deutsche Bank, but hindered by weak consumer sentiment and slower business activity. The ECB’s rate hold and US-EU tariff negotiations created a cautious but constructive backdrop.
South Africa’s JSE All Share Index hit new record highs above 100,000 amid strong global risk appetite and robust sector performance, particularly in resources and technology. Buoyant commodity prices, especially gold, and stabilising domestic politics provided further support, making South Africa one of the week’s standout equity performers.
Commodities
Brent crude breached $69/barrel as markets cheered progress on a US-EU trade agreement, anticipating that reduced tensions would spur global growth and oil demand. Supply-side forces further bolstered prices, including constrained Russian exports and tighter diesel markets due to new EU import restrictions and talks of sanctions on Russian oil. These factors offset demand concerns and underpinned the week’s rally.
Gold hovered near $3,360/ounce, consolidating earlier gains after a midweek pullback as risk appetite improved. Easing of global trade frictions and equity records prompted some investors to rotate out of safe-haven assets, but gold still managed a 0.6% rise for the week, benefiting from lingering uncertainty around US Fed policy and geopolitics.
Currencies
The US Dollar Index drifted to 97.5, capping losses for the week as easing trade tensions and strong jobless claims data shifted expectations of US rate-cuts further down the road. The prospect of a Fed pause next week and White House reassurances over central bank leadership reduced market anxiety, detracting from the dollar’s defensive appeal.
The euro touched $1.175/€ – close to three-year highs – before settling slightly lower after the ECB left rates on hold. Recent EU inflation data, along with trade uncertainties, underpinned the euro’s relative strength, although scepticism remains regarding an imminent breakthrough in US-EU tariff talks.
Sterling slipped to $1.354/£ from recent highs, reacting to weak UK PMI data which increased odds of BoE rate cuts despite better manufacturing results. A flurry of strong UK company updates, along with the UK-India trade deal ultimately lent support, offsetting much of the negative momentum from soft macro data.
The rand firmed against the dollar moving in tandem with rising JSE equities and elevated commodity prices. Steadiness in domestic bond yields, resilient mining sector profits, and improved global risk appetite provided support for the currency, despite local growth and fiscal headwinds.
*Please note that all information and data is as at the time of writing.
Key indicators:
USD/ZAR: 17.65
EUR/ZAR: 20.75
GBP/ZAR: 23.82
GOLD: $3,358
BRENT CRUDE: $69
Sources: Internal CAM Market Monitor, Trading Economics, Reuters, Bloomberg, Trading View, LSEG Eikon and Goldman Sachs Marquee.
Written by Citadel Advisory Partner and Citadel Global Director, Bianca Botes.