Potential triggers for sentiment this week1 :
- US: All eyes will be on the inflation data for July, expected at 8.7%, down from 9.1% in June. Other releases include PPI and the University of Michigan’s sentiment index.
- Europe: Final July CPI data for France, Germany, Italy and Spain. Eurozone factory activity.
- APAC: China July trade data; Australia consumer confidence survey.
- Global: Investors’ focus has switched from inflation, which they assume is being dealt with by central banks (except the BoJ), towards employment data that will confirm if consumers can willingly keep paying for higher prices.
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 continued to improve in all markets we track, except China and global emerging markets, which ended the week flat versus the previous week on geopolitical concerns. Sentiment is now moderately positive in all developed markets, while emerging markets and Asia ex-Japan remain close to neutral, lacking conviction one way or the other.
- Three factors are responsible for the current recovery in sentiment. First the belief that major central banks have now all admitted to the vice of having been behind the curve on inflation last year. In the manner of Alcoholics Anonymous, they have taken the first step towards recovery. Second, Q2 earnings have so far surprised on the upside, helping investors conclude that they had been overly bearish in their forecasts. And third, resilient employment data is raising hopes for a soft landing of the economy, instead of a hard one.
- Developed-markets sentiment is now in the Schrodinger zone. As long as inflationary pressures persist, investors are both hopeful corporate profits will not suffer as much as they previously thought, and, with the heavy irony available only to the hesitant, fearful that this this immunity won’t last. Perhaps the positive earnings so far, like the spoonful of sugar did to the bitter medicine, have only helped the news of further monetary tightening go down a little easier.
- Global emerging markets, Asia ex-Japan and China, remain too close to ground zero when it comes to the negative impacts of the trifecta of higher US interest rates, a slowing global economy and a deteriorating US-China relationship. These pressures are likely to keep investors in those markets on the defensive for the time being.
- Globally, as the Q2 earnings reporting season draws to a close in the next couple of weeks, daily news flow will revert to coverage of macroeconomic and geopolitical events. Prolongation of the war in Ukraine and a further deterioration of the US-China relationship means investors will pick up their newspapers in anticipation and put them down in disappointment. In that environment, sentiment, that other invisible hand of the market, can quickly develop jagged and dirty fingernails.
Jump to a specific market
US investor sentiment
Sentiment among US investors (green line) ended moderately positive last week, near its high for the year but unable to add to the previous week’s gains. Corporate earnings have projected a base-case scenario instead of a worst-case one, as far as the impact of inflation on profit margins is concerned. US consumers are in better financial shape than before the pandemic, and with the economy running at full employment, they have remained able and willing to pay higher prices without cutting back on their spending habits. The worry now for investors, is how long will this willingness last? For now, the economy gets the benefit of the doubt, and risk tolerance remains higher than risk aversion, but not by much. Volatility — the downside risk of being wrong — remains 50% higher than the average for 2021, reflecting the ongoing macro uncertainty in the market.
European investor sentiment
European investors’ sentiment (green line) remained strongly positive last week, edging slightly higher than the previous week. Sector allocations (red dotted line) also confirmed the ongoing implementation of more risk-tolerant strategies by investors, helping markets to rally higher. Risk tolerance is now significantly higher than risk aversion, helping turn a positive risk appetite into a driving force for markets as buyers of risk assets outnumber sellers. Since bottoming out in late February, sentiment has been on a recovering uptrend, turning positive once again in July. Strong macro and geopolitical headwinds remain in place, however. While corporate earnings seem to have been able to weather the inflation storm, uncertainty remains about the fate of the economy under a scenario of a prolonged war in Ukraine and further disruption to the region’s oil and gas supply from Russia ahead of the winter. For now, like US investors, the economy gets the benefit of the doubt, but further market gains will require evidence that this confidence isn’t misplaced.
Global developed markets investor sentiment
Sentiment among global developed-markets investors (green line) hedged up last week, ending close to the bullish zone (ROOF ratio >+0.5). Boosted by a more positive sentiment among both US and European investors, sentiment reached its highest level year-to-date. Sector allocations (red dotted line) stopped short of indicating a complete strategy pivot from risk-averse to risk-tolerant, depicting a rebalancing towards a more neutral strategy instead. The declining market volatility and pairwise correlations of the previous weeks, due in part to the better-than-feared corporate results, will have led to lower levels of active risk, allowing portfolio managers to increase their holdings of risky assets while remaining compliant with their mandates. Risk tolerance is now measurably higher than risk aversion, which supports further demand for risk assets among investors. This could lead markets higher in the short term.
Asia ex-Japan markets investor sentiment
Sentiment among Asia ex-Japan investors (green line) in the AP (After Pelosi) period shot up last week, ending neutral, after finishing bearish in the BP (Before Pelosi) period the previous week. Sentiment was weakened by geopolitical concerns around the US-China relationship and had not yet reacted to the relatively positive corporate results in the US. After a mostly incident-free visit by the Speaker of the House to Taiwan, sentiment rose sharply as a sign of relief, helping markets to start a recovery rally. Sector allocations the previous week pointed to the implementation of strongly risk-averse strategies ahead of Pelosi’s trip. Those trades were reversed in the final days of last week as investors’ focus switched to corporate earnings. Risk tolerance and risk aversion are evenly matched now, indicative of a neutral risk appetite.
Global emerging markets investor sentiment
Sentiment among global emerging-markets investors (green line) was unchanged last week, ending slightly negative but halting its recent descent. Sector allocations (red dotted line), likewise, indicated a halt to the implementation of risk-averse strategies, for now. The decline in sentiment this past month has been driven by the negative fundamentals higher US interest rates have for debtors in the region, especially Chinese real-estate companies with a heavy USD-denominated debt burden (e.g., Evergrande). Given that US interest rates are headed higher in the short- to medium-term, these pressures will remain in place and continue to weigh on investor sentiment. The current neutral risk appetite reflects the hope that the impact of hawkish monetary policies will not result in the previously feared worst-case scenario for the global economy, and that some kinder and shorter soft-landing can be engineered. TBC.
Japan market investor sentiment
Sentiment among Japanese investors (green line) rose sharply last week, ending in positive territory and at the highest level since May, when the lifting of COVID-19 travel restrictions uplifted sentiment. Sector allocations (red dotted line) surged ahead last week, as investors implemented more risk-tolerant strategies, reversing a trend favoring risk-averse portfolios that began back in early April. Risk tolerance is now slightly higher than risk aversion, but still reflective of a neutral risk appetite. Risk appetite has been positive three times already this year, but each time was unable to sustain the demand for risk assets, ending in a return to risk aversion as the preferred strategy. It remains to be seen if the current positive momentum behind rising risk-tolerance can be maintained in the absence of company-specific news over the coming weeks.
China (domestic) investor sentiment2
Sentiment (green line) among Chinese (A-shares) investors drifted lower last week, ending only moderately positive and well off its highs of late June. A combination of factors are weighing on sentiment, including a rising default risk (especially among the real estate sector), ongoing inflationary pressures, a slowing economy, and, of course, the recent deterioration in the US-China relationship. The political fallout from Pelosi’s visit to Taiwan remain to be seen. So far, the biggest loser seems to be (once again) the environment. Risk tolerance remains higher than risk aversion as we head towards the Communist Party’s annual convention in October, where President Xi will try to win an unprecedented third term. Many investors are betting on stimulus measures between now and then — nothing cements legitimacy like a surging stock market.
2 Note that as of the end of May 2022, we have switched to using a core benchmark as estimation universe instead of the broad market portfolio to better capture the behavior of institutional investor by removing the small caps from our analysis.