Only six months ago, the relationship between market sentiment and risk was very different than it is today. In June of 2018, high-risk companies generally enjoyed the strongest sentiment. Now the strongest sentiment tends to be associated with low-risk companies.
Measures of market sentiment are typically the fastest-moving signals we use to predict stock returns. We gauge sentiment using price movements, hedge fund positioning, forecasts of earnings and sales, and other metrics. The change that we’ve observed in sentiment over the past six months supports the observation that more normal levels of stock-market volatility are motivating investors to seek lower-risk, more defensive stocks. At the same time, this shift in sentiment provides a forward signal about the stocks that may benefit most from strong sentiment in the short term.