Qontigo ROOF Scores are now available for the following markets: China, Japan and Global Emerging Markets.
Potential triggers for sentiment this week1 :
- US – Minutes of last FOMC meeting, retail sales and industrial production
- Europe – UK inflation and retail sales, Eurozone Q2 GDP update
- Asia – China retail sales and industrial production, Japan Q2 GDP, Australia jobs report
1 If sentiment is bearish/bullish, a negative/positive surprise on these data releases could trigger an overreaction.
Summary of changes in investor sentiment from the previous week:
- Investor sentiment continues to tread at the bottom of the neutral zone across all markets we track. Persistent uncertainty about the strength of economic growth is weighing on investors’ risk appetite and pushing sentiment closer to the bearish zone.
- Market returns, meanwhile, have been at odds with a declining sentiment for multiple weeks now in several key markets. A prolonged divergence between markets and sentiment usually does not have a happy ending for investors.
- At these neutral but negative levels, sentiment becomes increasingly sensitive to bad news, especially if it is unexpected, and prone to over-reaction when it is released. At these levels, investors can be said to be no longer hopeful but not yet bearish.
- Sentiment in some markets is less negative than in others, but the trend is towards continued weakening rather than a turnaround. Investors seem to have gradually lost hopes for further strength in the economy in the face of increasing new infections from the Delta variant of the COVID-19 virus. Inflation, on the other hand, continues to raise its ugly head across a wide range of costs, affecting consumers on multiple fronts (i.e., food, rent, gas, mobile phones, etc.) in both developed and emerging economies.
- Overall, sentiment weakened further last week but not to the extent one would have expected given the persistent negative pandemic narrative across markets. Going forward we would expect the Covid-19 news to drive both sentiment and markets.
US investor sentiment:
US investor sentiment continues to drift aimlessly at the bottom of the neutral zone, refusing for the time being to be pulled down into the bearish zone. Market risk continues to be a non-event for investor sentiment but with volatility readings near their post-pandemic lows, any positive impact this metric could have on investor sentiment is very limited. Concerns over the strength of the economic recovery and the potential negative impact an increase in infections from the Delta variant of the COVID-19 virus could have on consumer behavior is weighing on sentiment. Markets continue to hit new historical highs, in defiance of a deteriorating sentiment, and the divergence between the two makes profit-taking increasingly likely. The reflation trade ended in May — investors have since returned to the pandemic profiteers — but even the FANGS are finding it hard to climb much higher from these levels.
Risk aversion (red line) remains elevated, and risk tolerance (green line) is well below its peer, creating a gap between the two that is much bigger than equilibrium would dictate. This indicates that the number of risk-averse investors is now sufficiently larger than the number of risk-tolerant investors and that this has become a buyer’s market. Any unexpected negative news could trigger a large supply of risk assets, forcing risk-averse investors to offer price discounts to induce risk-tolerant investors to purchase them (a.k.a. why markets fall). On the positive side, we note that the highs for risk aversion have been getting lower and the lows for risk tolerance have been getting higher since the February inflation tantrum, indicating that perhaps investors’ neutral stance may represent indecision more than fear.
European investor sentiment:
European investor sentiment ended last week at the bottom of the neutral zone. Market volatility has risen for the past two weeks, which has helped drive sentiment lower (green line). However, when looking at our sentiment indicator without the two risk metrics (red dotted line), we see an improving sentiment, meaning that sentiment may not be weakening as much as it seems. If market volatility resumes its decline, sentiment (green line) will rebound before entering the bearish zone. Markets have continued their upward trend but seem supported by investors’ choice of more risk-tolerant sectors (red dotted line). Unlike its US peer, market risk will decide where European investor sentiment goes from here.
Risk aversion (red line) and risk tolerance (green line) continued to diverge last week, but the gap between them stopped short of our definition for a bearish supply and demand imbalance. As with US investors, we note that the imbalance between risk aversion and risk tolerance has got smaller at each cycle since the start of the year, indicating a lack of confidence rather than any strong directional trend. Perhaps the return of investors from summer vacations in September will give markets a clearer direction.
Global developed markets investors sentiment:
Global developed market investors’ sentiment continues to be directionless at the bottom of the neutral zone; a situation like the one experienced last March. Market risk does not seem to be a concern for investors as sentiment appears to be driven by the choice of more risk-averse sectors over risk-tolerant ones. Global developed market returns have diverged from the declining sentiment for two consecutive months now, widening a dangerous gap between the two. At this point, it seems more like investors are buying stocks on faith rather than conviction, a situation that usually does not last long. Either authorities get control of the pandemic so that sentiment can rebound, or market prices must come down to reflect investor’s current risk appetite.
Risk tolerance (green line) declined and risk aversion (red line) rose sharply last week, creating a large imbalance in the supply and demand for risk in favor of supply. This is the largest gap since March this year, when markets fell 5%. Global market investors are notoriously more sensitive to geopolitical news than their regional or single-country peers. The third wave of new infections across both the developed and emerging world is pressuring the global supply chain and highlighting the differences across regions and countries on their ability to deal with the pandemic. The idea that developed countries will not overcome the pandemic until emerging countries do as well is starting to hit home with global investors.
Asia ex-Japan markets investor sentiment:
Since early June, Asia ex-Japan markets have been declining at the same rate as investor sentiment. Both ROOF Ratios (one based on style factors – blue line, and one based on sector allocations – green line) have been heading for the bearish zone in parallel, with the Style ROOF ratio ending last week in the bearish zone for the first time in 2021. Sentiment has been brought down by news of multiple lockdowns across the region on the back of rising new Covid-19 infections and a still low (in most places) vaccination rate. Even in countries with a high vaccination rate, like Singapore and Hong Kong, local authorities have imposed stricter social distancing measures in recent weeks. The region is also vulnerable to declining consumer confidence in Europe and the US, and may be reacting to the recent softness in retail sales numbers out of those two economies. The trend has been a downward one for both markets and sentiment, which means that unlike its US and European peers, markets in Asia ex-Japan are in-sync with investors’ risk appetite levels and may, therefore, have less downside risk.
The gap between risk tolerance (green line) and risk aversion (red line) narrowed further last week and ended with a slight advantage for risk aversion. Markets have been declining despite a positive risk appetite in June and July, indicating a greater skepticism on the part of investors here than in other regions. This is probably related to the fact that the region faced a bigger threat from the third wave of new infections and has been more proactive in terms of lockdown measures than its western peers, which benefit from higher vaccination rates. Despite two months of weakening, risk appetite remains at equilibrium and has not yet created such an imbalance between buyers and sellers of risk to pull markets down sharply from here.
Global emerging markets investor sentiment:
Sentiment among global emerging market investors has mirrored that of Asia ex-Japan investors and has been trending down for two consecutive months. Like its Asian peer, the Style ROOF (blue line) has already broken into the bearish zone, while the Sector ROOF (green line) remains in the middle of the neutral zone but on the same downward trend. Global emerging markets have responded to this decline in sentiment by falling almost 10% since their June 2021 highs. The mood in these markets is being driven down by the trifecta of slowing global growth worries, higher production costs from rising local PPIs, and pandemic-related disruptions to their supply chains. Until the pandemic is brought under control in these markets, both stock prices and sentiment will continue to come under pressure.
The positive net risk appetite seen in early May and again in June allowed emerging markets to rebound both times. This positive balance between risk tolerance and risk aversion has now closed after narrowing since mid-June. With sentiment becoming increasingly negative, markets will come under renewed pressure from rising risk aversion. Once sentiment becomes firmly bearish, over-reaction to further negative news can drive another market correction. On the positive side, valuations have been under pressure since their February 2021 highs and are not as stretched as their US or European developed peers, which should limit the downside from here.