Investor sentiment has bottomed out in every market we follow, except in China where investors remain unconvinced for now by the latest stimulus measures announced by the authorities, and in the UK where sentiment continues to decline, turning bearish this week in light of the Bank of England interest rate hike. Investors also remain in a bearish mood in three markets: global developed, global developed ex-US, and Europe. We also note that several markets (global developed, global developed ex-US, Europe, UK, and US) are defying sentiment by rising, as investors turned more negative. This implies that the latest rallies in these markets were being driven by increased demand for risk-averse assets, instead of a newfound willingness to speculate on riskier assets.
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Investor sentiment continued to decline in July, stopping just short of turning bearish before ending the month broadly neutral. Within the region, concerns about the strength of the economic rebound in China, as well as the impact of higher USD interest rates on high yield real estate borrowers, kept investors on the defensive. Low valuations after three consecutive years of underperformance and speculation that the USD interest rates may have reached their peak prompted some bargain hunting, lifting markets in July but, unlike the January rally, putting them out of sync with a weak investor sentiment. The supply and demand for risk (red and green lines in bottom chart) remains relatively balanced for now, with risk aversion having a slight edge as investors evaluate the effectiveness of the Chinese authorities’ stimulus plans for the world’s second largest economy. Anything short of convincing will translate into higher risk aversion levels and profit-taking in August, as markets come down to match sentiment.
Investor sentiment appears to have bottomed out in July, returning to a neutral level by the end of the month from the bearish levels reached mid-month. Encouraged by the third consecutive quarterly decline in inflation and a rebound in commodity prices, investors turned more positive in the second half of July, becoming more risk-tolerant than risk-averse for the first time since June. It remains to be seen if the July momentum in risk tolerance can be maintained throughout August and push sentiment from neutral to bullish, translating into higher market levels in Q3. Any headwinds will have to come from the property market in the form of further price declines and rising loan default rates for banks. On the plus side, further tailwinds would have to come from renewed strength in China’s economic rebound translating into (even) higher commodity prices.
Investor sentiment in China remained range-bound in July as investors awaited further details of the authorities’ economic stimulus plan. Earlier this year, both markets and sentiment were lifted by talks of stimulus, which eventually came up short of investor expectations, sending sentiment back down in July. At the second time of asking, it would seem as though investors demand to see details of new stimulus measures before they buy into the premise of their eventual success. Measures announced so far only alleviated the liquidity concerns investors had, especially around high yield debtors in the property sector, but are not seen as enough to turn the economy around in the short term. Risk tolerance and risk aversion levels ended the month of July evenly matched, eliminating the risk of a sharp downside overreaction by investors for now, but failure to release a detailed and credible stimulus package could send sentiment south and send markets down for a test of their June lows. For the authorities, the message from investors is simple, no more talk. Go big or we go home.
Investor sentiment among Japanese investors weakened slightly in July, ending marginally negative with risk aversion remaining higher than risk tolerance for most of the month. Year-to-date in Japan, the story has been about both the weakening Japanese Yen and the relocation of the global technology supply chain outside of China. The former benefited exporters and the latter did the same for large manufacturers in the industrial sector. Going into August, the late July market rally, accompanying a weakening Yen, opened a gap with the declining investor sentiment. Meanwhile, the supply for risky assets remains higher than the demand for them, as it has been for most of July. This imbalance could worsen in the short term, with a strengthening Yen and increased market volatility.
Charts display changes to investor sentiment over the past 180 days for each market
How to read these charts: The top charts show the ROOF ratio (investor sentiment) in green (left axis), against the cumulative returns of the underlying market in black (right axis). The horizontal red line at -0.5 (left axis) represents the frontier between a negative sentiment (-0.2 to -0.5) and a bearish one (<-0.5), and the horizontal blue line at +0.5 (left axis) represents the frontier between a positive sentiment (+0.2 to +0.5) and a bullish one (>+0.5). Around the horizontal grey line at 0.0 (left axis), sentiment can be considered neutral (-0.2 to +0.2).
The bottom charts show the levels of both risk tolerance (green line) and risk aversion (red line) in the market. These represent investors’ demand and supply for risk. When risk tolerance (green line) is higher than risk aversion (red line), there are more investors looking to buy risk assets then investors willing to sell them (at the current price), forcing risk-tolerant investors to offer a premium to entice more risk-averse counterparts to take the other side of their trade, which drives markets up. The reverse is true when risk aversion (red line) is higher than risk tolerance (green line). The net balance between risk tolerance and risk aversion levels is used to compute the ROOF ratio in the top charts, representing the sentiment of the average investor in the market.
The blue shaded zone between levels 3-4 for both indicators represents a reasonable balance between the supply and demand for risk in the market. Conversely, when both lines are outside of this blue zone, the large imbalance in the demand and supply for risk can lead to an overreaction to unexpected news or risk events.
For questions or comments about this data, please contact the Qontigo Applied Research team.