by Olivier d'Assier
Potential triggers for sentiment this week1 :
- US CPI and consumer confidence for July
- UK Q2 GDP and Eurozone production numbers
- Tail end of Q2 earnings reporting season
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 remains in indecision land across all markets we track. And if you are a regular reader of these highlights, then you’ll know that sentiment, globally, has been stuck between slightly negative and slightly positive for the past four weeks.
- Globally, good news on the earnings front is being hedged by negative news on the pandemic front. Strong consumer demand is being matched against strong inflationary pressures. Continued monetary stimulus is being weighed against slowing economic growth. And we haven’t talked about geopolitics yet.
- A strong Q2 earnings season seems to have done nothing for sentiment other than confirm the benefits of a low base (Q2 2020). Valuations are now well above their historical norms and markets are seemingly stronger than investor sentiment would normally dictate.
- The lack of predictability on the pandemic response front across developed economies, as well as the continued global supply chain disruptions across developing ones, is guaranteed to keep investors in the dark and induce tunnel vision and highway fatigue.
- On a positive note, they seem reluctant to turn bearish for fear of missing out on a rally from a stock market where nothing seems to succeed as consistently as repeated failure.
US investor sentiment:
US investor sentiment drifted further down last week to end at the bottom of the neutral zone. Sentiment weakened both with (green line) and without (red dotted line) the two market risk metrics, indicating that the decline in sentiment is driven by both investors’ needs and wants. Markets have gone in the opposite direction, exacerbating a divergence with investor sentiment that can only be explained by a strong penchant for risk-averse strategies by the latter. The (expected) strong Q2 earnings season did not disappoint but the low-base effect helped muddle, instead of clarify, the picture for investors, who now seem more concerned about the future (i.e., Q3) than the past (i.e., Q2). Sentiment seems parked in the neutral zone, awaiting Q3 data on both economic fundamentals and corporate earnings, to help investors make up their minds.
Risk aversion (red line) peaked, and risk tolerance (green line) bottomed out at opposite ends of the equilibrium zone, fixing the slight imbalance in the supply and demand for risk in favor of supply. The gap between the two remains indicative of only a mildly negative bias, where investors are not yet bearish but have already lost their cautious optimism. In this state of mind, they will become increasingly sensitive to negative narrative in the news flow.
European investor sentiment:
European investor sentiment ended last week in the “Schrodinger zone,” where future market direction is both up and down until clear evidence of either one emerges. Both indicators accounting for (green line) and without (red dotted line) changes in market volatility ended the week in the same place with the latter rising to meet the former. This indicates that uncertainty, and not market volatility, is driving investor sentiment. Unlike their US counterpart, European markets have not run away from sentiment and remain range-bound at recent highs, awaiting to be pushed or pulled in one direction or the other. The lack of market direction should continue to mirror the lack of investor confidence until clarity returns.
Risk aversion (red line) and risk tolerance (green line) remained at equilibrium last week, representing a balanced supply-and-demand situation and a neutral risk appetite. Year-to-date, European investor sentiment has gone through two full cycles and are midway into their third one. So far, each cycle has been less emotional than the previous one with the imbalance between the supply and demand for risk diminishing at each iteration. In this third cycle, risk aversion barely broke above risk tolerance, in a sign that uncertainty is once again making it harder and harder for investors to gain confidence in their forecast.
Global developed markets investors sentiment:
As with its regional peers, global developed markets investor sentiment crawled aimlessly along the bottom of the neutral zone last week. The last time sentiment had this lack of direction was right after the February inflation tantrum in the US, when investors debated whether to believe the Federal Reserve’s prognostic for short-lived inflationary pressures and continued monetary easing. Today, they seem to have made their peace with the inflation threat and are more concerned about slowing economic growth. Similarly, sentiment excluding any market volatility concerns (red dotted line) is reflecting that investors are currently favoring risk-averse strategies. Markets have kept their heads above water while investors, it seems, feel like the water level is exactly at their head. Economic data releases over the next few weeks will either poor rain or sunshine on sentiment.
Risk tolerance (green line) and risk aversion (red line) remain too close to each other to create much of a price instability in the market. In this stalemate situation, sentiment remains too weak to give either side the confidence it needs to move far away from current prices; it is neither a buyer’s nor a seller’s market. Year-to-date, the market remains on an uptrend but we note that this has benefitted risk-averse strategies a lot more than risk-tolerant ones (see upcoming blog post on the subject).
Japanese investor sentiment (the Asia ex-Japan segment will return next week):
Japanese investor sentiment has been declining steadily since mid-June and ended last week on the border between neutral and bearish. The Japanese market has twice (March and June) tried to break into higher territory, but faltering investor sentiment dragged it back down both times. At this level, Japanese investors are no longer hopeful and are dangerously close to becoming bearish. It will take a lot of positive news to lift their spirits back to a level where cautious optimism is once again conceivable. Until sentiment rises again, markets will remain under pressure and are unlikely to make a break for new highs without the support of investor confidence.
The gap between risk tolerance (green line) and risk aversion (red line) increased further last week, creating an imbalance in the supply and demand for risk in favor of supply. Risk appetite in Japan is now clearly negative but not yet dangerously so. The last time risk aversion was this much higher than risk tolerance was in late February/early March, and the market suffered a 5%-plus correction then. A good showing for the local team at the Olympics does not seem to have been enough to lift investors’ spirit. More good news is needed.
