Potential triggers this week: Several moderately impactful economic data culminating in the US jobs report for June on Friday, but nothing that would trump the impact from rising numbers of new cases and the increased likelihood of a second wave scenario. Investors will focus on daily Covid-19 data and signs of a corresponding policy response from authorities.
Summary: Investor sentiment hoovers above the neutral zone like buzzing flies over a dung heap for the third consecutive week. The decline in risk tolerance was halted by positive economic data for May from the reopening phase. Simultaneously, the rise in risk-aversion, started by an increasingly negative narrative around a second wave of Covid-19 cases, has also slowed. Fear of missing out (FOMO) means investors are looking for reasons not to buy instead of reasons to sell. The next few weeks will see positive backward-looking economic data continue to battle negative numbers on the Covid-19 front. The tipping point is likely to only be met when either talks of a second wave of lockdown measures is heard, or China makes good on its threat to pull-out of the Phase One trade deal. A wise man once said, the best time to build the roof is before the rain. The probability of a W-shape recovery instead of a V- or U-shape one, is increasing with every new case.
US Investor’s risk tolerance has stalled but their risk-aversion is rising, signaling an increasingly cautious optimism that the worst of the economic crisis is behind them.
Economic data for May and June was supposed to close the gap between Wall Street’s V-shape recovery hopes and Main Street’s economic pain from the March-April lockdowns. The post-lockdown return to normal, however, was anything but. Social unrest, growing geopolitical tensions, and rising new Covid-19 cases led to the U-shape (or Swoosh-shape) scenario becoming the new front runner. Dark W-shape recovery clouds can now be seen and thunder from a second wave of new cases that surpasses the height of the first wave can already be heard.
The decline in sentiment from confidently positive to cautiously optimistic was big enough to trigger a negative change of sentiment signal, although the ROOF ratio remains above +0.5 meaning that the supply and demand for risk is still favors demand, but the imbalance isn’t big enough to create the need for premiums to be offered in order to acquire risk assets which explains the sideways market over the past three weeks. The rank of risk-averse investors is growing as the dents in the V-shape recovery scenario keep coming in, any confirmation of a W-shape recovery will make them swell.
Sentiment in developed Europe continues to be cautiously optimistic.
Sentiment and markets in developed Europe remain mostly flat and continue to take their cues from European data on both the economic recovery and the rate of new Covid-19 cases. Heading into July, lagging economic data for May and June should confirm a bottom for the economy in April but investors in that part of the world were never as optimistic as their brethren across the pond in buying into the V-shape recovery scenario, hoping for a U-shape one instead.
They will be looking nervously at the second wave of Covid-19 cases in the US for signs that another round of lockdowns is required, but at this point, they seem to have reached a comfortable equilibrium between the demand and supply for risk at current levels, giving them a slight positive conformation bias. With the market recovery thus far at only 50% of the March tumble, there is upside potential if good news triggers the meager positive bias into action, but given the increasingly negative coronavirus narrative in the US and the acrimonious geopolitical dialogue to-date, it is hard to see where that would come from.
Risk appetite continues to weaken in both global developed and Asia ex-Japan markets.
Investors in both global developed and Asia ex-Japan markets continue to be less risk-tolerant and more risk-averse, taking overall sentiment for both markets into the neutral zone, sharply so for Asia ex-Japan investors.
Global and Asia ex-Japan investors are more sensitive to geopolitics than their domestic market counterparts. Rising tensions between the US and China as well as the UK and the EU, both over trade issues, is causing a dent in risk appetite for these investors who, like beauty pageant contenders, favor world peace. In this light, Friday’s Chinese response to the US Senate’s passage of a bill condemning China’s handling of the Hong Kong situation, is making these investors very nervous. They will be closely monitoring the tone of the rhetoric between the two leaders over the next few weeks for signs that the trade war truce is now over.