Inflation, macroeconomy and stock market sentiment: A tale of 2023

This insight series with Probability & Partners delves into contemporary observations and insights, covering topics such as media sentiment in financial markets, advancements in generative AI, and more.

• This first insight focuses on news sentiment surrounding major stock market indices. 
• We explore how news sentiment has evolved over 2023 in response to macroeconomic and monetary policy events, particularly in the UK, EU, and US markets.
• By considering quantitative news characteristics such as relevance, novelty, and sentiment, our indicators provide insights into sentiment trends. Aggregating these signals across asset universes allows us to gauge sentiment about major stock markets like the FTSE 100, S&P 500, STOXX 600, NASDAQ 100, and others.

We've often witnessed the unique value of company sentiment monitoring in both risk reduction and return enhancement within investment strategies. During the onset of the COVID crisis we observed a consistent and sharp decline in sentiment across all major stock markets, weeks before COVID-19 became a prominent topic. The stock markets eventually experienced a dramatic downturn, and the preceding decline in sentiment served as a valuable and timely warning indicator, occurring up to four weeks in advance. 

The strength of sentiment lies in its ability to signal such significant downturns effectively. However, stock market sentiment also reflects various other events, including inflation and monetary policy announcements, growth forecasts, geopolitical tensions, and any other pertinent information influencing stock market performance.  An examination of regional market sentiment and stock market performance in 2023 reveals very different stories for the UK, Europe and US. 

In particular 2023 was rich in such events, with inflation, interest rates, and growth concerns dominating both the economy and the media landscape. Despite this backdrop, sentiment surrounding the UK stock market (FTSE 100) generally remained positive. However, significant sentiment swings were observed throughout the year, particularly in June and September 2023. In June 2023 a cascade of adverse economic news struck the UK: reports of high inflation which exceeded predictions, and sluggish growth featured in the media. Despite an inflation expectation of 5%, the actual figure soared to 8.7%. Additionally, Q1 results indicated a slow start for the UK economy, raising concerns about the risk of recession. While mainstream news acknowledged these issues at the end of June, we observed a decline in related stock market sentiment two weeks prior. Specifically, June 19 and 26 witnessed the largest sentiment drops, although the downward trend commenced on June 15: from around that time, a trickle of gloomy news regarding high inflation, elevated gilt yields, long-term stagnation, and an increased number of bankruptcies emerged. Overall, it seems that the inability to curb, and accurately forecast inflation significantly impacted stock market sentiment.

On September 15, the UK stock market sentiment experienced its largest daily increase of the year, prompted by the announcement of a larger-than-expected inflation slowdown. This positive momentum was however short-lived, as September 20 saw the biggest sentiment drop of the year. This decline followed the reduction of growth forecasts to just 0.1%, accompanied by fears of the UK slipping into recession by the end of 2023 (these fears materialised, as the UK indeed confirmed its recessionary status by the end of the year).

In contrast to the UK, the sentiment surrounding the EU stock market (STOXX 600) in 2023 appeared notably less positive, largely influenced by the significant contraction of the EU economy stemming from the Russia-Ukraine conflict, which dominated both economic and media sentiment. Once again, September witnessed the most pronounced sentiment volatility, characterised by substantial swings ranging from -20% to +50% in a single day. Such drastic fluctuations typically signify a lack of consensus within the media regarding the state and trajectory of the stock market. The EU exemplifies this, as sentiment appeared to vary significantly among member states, with Southern countries like Spain exhibiting generally positive sentiment while Northern European countries struggled. Economic news in September for the EU was predominantly pessimistic, featuring negative outlooks, stagnant growth, and downward revisions of economic forecasts. These developments were duly reflected in the sharp decline and volatile sentiment of the EU stock market (which was partially alleviated a little later by the release of better-than-expected results).

The analysis of US stock market (S&P 500) sentiment provides fascinating insights. The most notable sentiment downturn occurred in the immediate aftermath of the US banking turmoil in March 2023, triggered by the failures of Silicon Valley Bank and Signature Banks. Interestingly, this decline did not manifest in the S&P 500 itself, as it was largely confined to the financial sector. A similar dip was observed in EU stock market sentiment at the end of March, following turbulence surrounding Credit Suisse. Subsequently, US stock market sentiment improved around June, coinciding with Fed rate hikes and the debt ceiling agreement. However, concerns over US inflation (reaching a reported peak of 9%), similar to those in the UK, dominated (and suppressed) stock market sentiment in late June to July. 

October witnessed another dip in sentiment, presumably following the onset of the Israel-Palestine conflict, an event not mirrored in either UK or EU sentiment. This was followed by a decline in the S&P 500 index a few weeks later, as we often observe. Towards the end of October, interest rates reached a peak, accompanied by the arrival of positive macroeconomic indicators. This initially lifted stock market sentiment, subsequently boosting the index itself. This positive trend continued towards the year's end, with media reports highlighting strong demand numbers and robust GDP forecasts. However, sentiment took a downturn towards the very end of 2023 due to speculations of a possible US recession. Despite this decline in sentiment, the S&P closed the year up 9%, indicating an uncommon occurrence where the sentiment decline did not correlate with a similar decline in the index itself. This anomaly warrants further investigation to understand the underlying dynamics at play.