by Olivier d'Assier
In the news this week: German, UK, and Japanese consumer confidence. US durable goods orders, EU business confidence, and BoE rate decision. Late in the week, Q4 GDP estimates for France, Spain, Italy, the US and the Eurozone. US personal income and spending on Friday and the third Brexit deadline on Saturday. In the US the Q4/2019 earnings season continues. (From: https://tradingeconomics.com/)
Summary: Investor sentiment remains supportive of higher market levels in all markets we track except for Japan and the UK where it remains unsupportive1. Note that this support has been weakening in the US, China, Asia ex-Japan, and Japan since reaching a high in Q4 last year. Conversely, support in global emerging, global developed, Australia, and developed Europe has only recently reached their highs. Overall, investors remain more in the mood to reward than punish, but that feeling is weakening.
- For the second week in a row support for higher market levels in the US has been weakening. After failing to reach above the highs of early December, support has dropped by another 20% this past week to end just above the supportive level of +0.5.
- Support in Japan has now dropped to zero from the highs (+1.9) reached in early December and the market has found it hard to make any headway this year sharply underperforming its developed peers YTD.
- In China, sentiment has been oscillating around the key support level of +0.5 since climbing above it in mid-December. Since then, the market is up almost 6%, but with support being so fragile, and the coronavirus having erased a large part of consumer spending around Chinese New Year, sentiment may weaken further in the near term, taking the market with it.
- Sentiment in the UK is no longer unsupportive but remains neutral ahead of the deadline with no post-Brexit plan yet.
Sentiment peaked in the US market in early December and has been on a mild downtrend since but remains in supportive territory. Will that last?
The overall sentiment levels in the US has remained supportive of higher market levels but what has been happening underneath points to lower support ahead. Since January 10, investors have started to favor companies with low leverage and higher dividend yield, two style tilts traditionally preferred by risk averse investors. Additionally, they have switched out of high-beta stocks into lower-beta ones since December 27th. These style shifts point to rising risk aversion levels meaning that investors are becoming more sensitive.
As of the end of last week, the metrics in favor of risk tolerance were mildly ahead of those for risk aversion six-to-four, but with market volatility rising due to the coronavirus outbreak, the two risk-related metrics may switch side in favor of risk aversion this week, tipping the balance of sentiment into unsupportive territory in the near term. It will be up to the earnings season and CEO’s forward guidance to reassure markets and turn sentiment around.
Sentiment continues to weaken in China and may not be able to hold current (mildly) supportive levels going forward
Sentiment in China had recovered from the Q3 2019 lows and became supportive again since news of the US-China mini deal, helping the market recover from its August lows and rise 20% since then on hopes an end – or a truce – to the US-China trade war would return their economy to its previous growth path. The BOC had also been accommodative. This made risk tolerant styles of volatility, leverage, high beta, small cap, and growth, once again the darling of investors who shunned risk averse styles like dividend yield, low vol, and value in pursuit of short-term leveraged capital gains.
This all changed earlier this month as economic data revealed a deeper slowdown than investor had feared. Volatility started to rise and risk averse styles like profitability, large caps, and low beta came into favor once again, swelling the ranks of risk aversion metrics. Overall sentiment is on the edge of being supportive as of last week but as investors return from the Chinese New Year break and assess the impact of the coronavirus outbreak on consumer spending during the festivities, we may see the balance tip strongly in favor of risk aversion when they return.
Sentiment in Developed Europe staged a strong recovery since mid-December but style drift underneath hints at another turnaround in the near term
Investor sentiment in developed Europe returned to a supportive stance earlier this month after briefly dipping into unsupportive territory in December. Since mid-January, however, investors have started to favor large caps, low beta, profitable, companies that pay higher dividends while still retaining their bet on growth and against value. Overall, as the bottom tables below show, investors had been mostly risk-tolerant until last week.
With volatility rising on the back of both the coronavirus outbreak and fears that President Trump may now focus his ire on the European trade relationship, we may see risk aversion styles gather more momentum and start to turn investor sentiment into unsupportive territory once again. There remain many unanswered questions as to the EU’s relationship with the UK post-Brexit, and given already negative interest rates in the region, weather the ECB can provide material assistance in the case of a trade war with the US. This uncertainty is reflected in the style drift we see in Europe. Will it soon be Value’s time to shine again in that market?
1. We have switched to using ROOF Ratios instead of the ROOF Scores as of the start of 2020. “Supportive” is a reading above +0.5 and “unsupportive” is a reading below -0.5 on the ROOF Ratio.
