Qontigo ROOF Highlights will take a break for the next three weeks and will return on Monday, January 10, 2022.
Potential triggers for sentiment this week1 :
- US: Federal Reserve meeting, flash PMI and retail sales data.
- Europe: ECB and BoE meetings, Eurozone flash PMI and industrial production data, and UK inflation.
- APAC: BOJ meeting, Japan and Australia flash PMI data, China retail sales and industrial production, and Japan Tankan.
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 weaken across all markets we track last week, with global developed and China market investors becoming bearish. Sentiment among US developed Europe and Japan investors managed to avoid the same fate but remains strongly negative ahead of key central bank policy meetings this week.
- Too many factors are weighing on sentiment and increasing the uncertainty risk premium for investors. Top of mind is whether central banks are falling behind the curve on inflation and how to forecast global growth in an upcoming era of asynchronous monetary policy.
- Additional worries on the docket for next year include local policy responses to the spread of the Omicron variant and its impact on the global supply chain. Rising tension in geopolitics will also occasionally trouble the sleep of those who care about world peace (i.e., US-China relations, Russia-Ukraine, UK-EU, Iran, and North Korea’s paranoid and megalomaniacal version of The Sopranos now in its eleventh season).
- For the rest of the year, light holiday volume increases the chance of an overreaction to negative news on any of the above concerns. Add to that the current lofty valuations across developed markets, the highest rate of insider selling in the last six years (according to the WSJ), and an as-of-yet unknown fallout from corporate bond defaults out of the Chinese real estate sector. These worries should dominate sentiment until the next quarterly earnings reporting season.
US investor sentiment:
US investor sentiment (green line) rebounded off the frontier between the neutral and the bearish zone last week, helped in part by news of easing supply-chain issues and an improving job market. All eyes this week will be on the Fed’s monetary policy meeting and any guidance as to the timing of a widely anticipated increase in the key interest rate. At this point, the danger for sentiment and markets would be for investors to interpret the Fed’s laconic stance towards inflation as a languid one. The next batch of fiscal stimulus spending is still making its way through the Senate, and it remains uncertain if it will be passed before Congress breaks for the holidays. With the mid-term elections next year, partisan politics will increasingly become a game played for keeps. Year to date, risk-off strategies have outperformed risk-on ones. With sentiment remaining negative in the short-term, it does not look like momentum will rotate towards the implementation of a confidently bullish view until the veil of inflationary uncertainty has been resolutely lifted.
Risk aversion (red line) and risk tolerance (green line) reconverged slightly last week but remain far enough from each other to reflect a lack of confidence among investors. The net negative risk appetite and the light volume around the holiday period puts the danger more on the downside at this point. The uncertainty surrounding the impact of the Omicron coronavirus variant during the winter months increases the validity of the adage about (risk-tolerant) fools and their money going separate ways. A risk-averse strategy has worked well all year for investors, and the ongoing weak sentiment points to more of the same in the short term.
European investor sentiment:
European investor sentiment (green line) continued to rise on the back of the ECB’s assurances of ongoing supportive monetary policy, but ended the week still on the negative side of the neutral zone. Threats to the economic recovery remain, however, with potential lockdowns in Germany and other markets. These headwinds have prompted investors to begin actively implementing more defensive strategies via both sector and style factor rotations (red dotted line). Europe faces an uncertain winter with uneven recoveries, disparate pandemic responses, and the threat of an armed conflict on its easter flank. These risks, combined with a weak sentiment and rising market volatility ahead of the holiday season. also serve to increase the chance of a downside overreaction to further negative news. At these levels, sentiment is unlikely to be able to lift markets but has the potential to pull them back down to recent October lows given the light volumes in the next few weeks.
Risk aversion (red line) and risk tolerance (green line) remain very close to each other and near equilibrium. This indicates that the imbalance between the potential supply and demand for risk assets isn’t a threat to markets at this time, but the bias is still on the side of risk aversion given the recent past. A deteriorating situation on the Ukrainian eastern border could easily tip the balance back towards a negative risk appetite, creating an oversupply of risk assets and driving markets sharply lower in the thin holiday volume.
Global developed markets investors sentiment:
Sentiment among global developed-markets investors (green line) hovered near the top of the bearish zone last week but failed to get the positive momentum needed to cross over into the neutral zone. The rapidly rising uncertainty caused by multiple factors, as well as the unsynchronized response to inflationary threats by the major central banks, is making it harder for global developed investors to build reliable forecasts for Q1 2022. Increased market volatility, driven in part by rising country and currency risk, and the declining end-of-year volumes, is prompting more investors to implement risk-averse strategies to protect their gains amassed this year.
Risk tolerance (green line) and risk aversion (red line) remained far apart last week, with the potential supply of risk asset dwarfing the potential demand. Risk appetite for global developed-market investors is in bearish territory since the middle of the previous week and could result in a rapid sell-off if central banks further disappoint investors with their intended response to current inflationary pressures. Investors have spent most of the year implementing risk-averse strategies and getting rewarded for it. The time to flip sides isn’t here yet given the high level of macro uncertainty.
Asia ex-Japan markets investor sentiment:
Sentiment (green line) among Asia ex-Japan investors continued to weaken last week, ending just inside the neutral zone. In contrast to their western developed-markets counterparts, Asia ex-Japan investors have spent most of this year implementing risk-tolerant strategies but have yet to be rewarded by markets, and are headed into 2022 with cumulative year-to-date returns of -6%. The region faces several headwinds for next year, with the threat of higher US interest rates, a stronger USD and a heightened credit default risk centered around Chinese real-estate conglomerates. The Chinese economy was the first to rebound from last year’s pandemic but is now also the first to show signs of weakness and vulnerability in the face of the Omicron variant. Further calls for lockdown measures in China would add to the region’s economic woes by further stifling both local economy and the global supply chain. On the geopolitical front, the deteriorating relationship between the US and China adds another point of concern for investors, as does the situation between China and Taiwan. These will continue to weigh on sentiment in 2022, when both topics will likely become a feature of the mid-term election rhetoric in the US.
Risk tolerance (green line) declined further last week as risk aversion (red line) continued to rise, almost closing off a positive risk appetite that had opened since early October. Last month’s strong positive risk appetite failed to convert the market rally into a sustainable bull run. As risk tolerance weakens further in the closing weeks of the year, the lighter volume is likely to exaggerate any downside moves, but if sentiment remains positive, bargain hunting should limit the drawdowns.
Global emerging markets investor sentiment:
Sentiment among global emerging-markets investors (green line) flattened out just inside the bullish zone, halting its descent from a strongly bullish reading last month. In the past month, markets have been at odds with investor sentiment, refusing to reward risk-taking with positive returns like they had in Q2 2021. Worries over the strength of the Chinese economy and the possible fallout from credit defaults of two large Chinese real-estate companies may put pressure on sentiment and markets in the final weeks of the year, especially if the US Federal Reserve hints at higher US interest rates as early as Q1 2022. Add to this worries about the impact of the Omicron variant on emerging economies given low vaccination rates, and global emerging-markets investor sentiment my fall as fast as that of China in recent weeks.
The positive gap between risk aversion (red line) and risk tolerance (green line) remains in place but is now about half as wide as it was a month ago. Risk tolerance has been above risk aversion in global emerging markets for most of 2021, yet cumulative market returns are still negative as global fund flows remain anchored in developed markets. The threat from the Omicron variant as well as higher US interest rates next year will act as double headwinds for emerging economies, which are already seeing an erosion of profit margins from higher producer and energy prices, as well as shipping rates. Short-term, it is hard to see how emerging markets with negative risk-return trade-offs, can attract global investors away from developed markets.