Potential triggers for sentiment this week1 :
- US: January CPI and consumer confidence. Earnings from Coca Cola, PepsiCo, Pfizer, Twitter, and Walt Disney.
- Europe: UK Q4 GDP data.
- APAC: Chinese markets reopen after a week-long break; Japan consumer spending data.
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 remained bearish last week across all developed markets and Asia ex-Japan. Emerging-markets investor sentiment continued to decline, even in the absence of China for the lunar new year holidays, ending negative but just shy of bearish.
- Last week’s admission of the potential need for higher interest rates by Christine Lagarde was taken as a sort of Chekhov’s gun by European investors, who now fully expect the ECB to make use of higher rates in Act 2 of 2022. The latest set of CPI data across major economies certainly gives the central bank casus belli to fight inflation sooner rather than later. And so, this time isn’t different after all.
- The bearish sentiment that has engulfed markets this past month has all to do with (negatively) changing fundamentals and their potential impact on corporate earnings, and hence on valuations. Next to that, Putin’s Ukraine theatrics, or Kim Jung-un’s seven missile tests in a single month (!), seem more like squawks for attention than cries of real pain.
- Historically speaking, contained and fleeting military conflicts outside of the developed world do not have a lasting impact on market returns or investor sentiment. Not to make light of the situation in these countries, but weekly returns data on developed markets is not just saying there is no there, there. It is saying there is no there, period.
- For the first time in almost two years, sentiment failed to get a boost from quarterly earnings reports. Instead, investors seem to have internalized the idea that in the exercise of their mandate, central banks are always going to be selling somebody out. Time to rank companies based on their exposures to fundamental factors such as leverage, growth, value, size, etc., as a hawkish monetary policy introduces a new ladder for investors.
US investor sentiment:
US investor sentiment (green line) dipped to a new low last week before recovering slightly on Friday. The dip in market volatility (from the low 30s to the low 20s), has led to some bargain hunting on companies with positive earning stories (red dotted line), but momentum remains driven by the popularity of bearish strategies rather than bullish ones. The strong negative sentiment means that overreaction to negative news and underreaction to positive ones will prevail, creating both higher dispersion and volatility for markets in the short term. A bearish sentiment will continue to weigh on markets, resulting in two steps back for every one step forward.
Risk aversion (red line) rose to new highs while risk tolerance (green line) declined to new lows last week. The gap between them continues to be too large for a return to calm as potential sellers outnumber potential buyers more than two-to-one. A worse-than expected CPI number on Thursday could trigger a large downside overreaction, especially if it is seen as altering how high and how fast the Fed will need to raise rates to fight it.
European investor sentiment:
The ECB giveth and the ECB taketh away. The central bank’s continued dovish stance was a major source of support for European investor sentiment (green line) which counted on consecutive pro-growth statements to rebound each time it became too negative. As Christine Lagarde announced the ECB’s own inflation pivot late last week, this safety net could easily turn into a strong headwind for the economy. The only beneficiaries would be European banks. In the short term, if the winds of monetary change are seen as imminent, investors are likely to rotate their sector allocation with the implementation of a more defensive strategy. As of now, European investor sentiment remains bearish but not as much as two weeks ago. This week will give us the first glimpse at their reaction to the ECB’s new line of thought.
Risk aversion (red line) and risk tolerance (green line) remained mostly flat last week but still far apart from each other, with potential sellers still far outnumbering potential buyers. The recent rebound in sentiment has been almost exclusively driven by a slight pullback in risk aversion from its 52-week highs reached at the start of the year. Risk tolerance has flatlined near its lows year-to-date. In this light, sentiment is more likely to continue to be driven by negative news rather than positive ones.
Global developed markets investors sentiment:
Sentiment among global developed-markets investors (green line) retraced its recovery steps, ending more bearish than the previous week. This relapse was mostly caused by a resurgent market volatility as the recovery in sentiment based on sector allocation alone (red dotted line) continued to rise, signaling that investors have been implementing strategies that are more risk tolerant than risk averse in the last two weeks. As noted last week, this contrarian trade may be more due to bearish fatigue than any data-driven strategy shift since inflation is still on the rise globally and neither the Fed nor the ECB have started to raise rates to fight it.
Risk tolerance (green line) declined slightly last week while risk aversion (red line) rebounded sharply, but the latter ended below its recent highs. Risk appetite remains very negative with potential sellers outnumbering potential buyers more than two-to-one. Any negative news could trigger an overreaction by sellers who have already seen any capital gains made since last September wiped out in the last month-and-a-half.
Asia ex-Japan markets investor sentiment:
Investor sentiment (green line) ended the week slightly lower than the previous week and is still bearish since early December 2021. With most Asian markets partially closed for the Lunar New Year festivities during the first part of the week, only Friday’s sharp reversal in sentiment should be considered regional. Higher US interest rates is not good news for the region. Neither are higher euro interest rates. Any further deterioration in the inflation picture in developed markets will increase the forecast for higher rates in response and add to the negative story for Asia ex-Japan. If the global economy slows down and debt becomes more expensive to service, even the current low valuations may need to be revised downward.
Risk tolerance (green line) remained flat last week while risk aversion (red line) made a sharp rebound as investors returned from their festivities to learn about the ECB’s own inflation pivot. As with other major markets, sentiment has been driven since the start of the year almost exclusively by changes in investors’ risk aversion levels. One of the reasons behind the seasonally lower risk aversion was strong corporate earnings out of the US, ample market liquidity, and the availability of cheap credit. All three may be at risk in a higher interest-rate environment.
Global emerging markets investor sentiment:
Sentiment among global emerging-markets investors (green line) ended its recovery and closed last week lower than the previous week. With China closed for the full week, the change reflects mostly Latin American investor sentiment. This week sees the return of Chinese investors, which should provide a more comprehensive picture. Year-to-date, (much) lower valuations have provided some downside protection for emerging markets but going forward the threat of higher debt servicing costs will need to be offset by forecasts for higher global economic growth and lower inflation. Failure to get inflation under control by major central banks, without too much damage to the economic growth story, will lead to further downside in both sentiment and share prices in emerging markets.
Risk aversion (red line) last week rebounded off its lowest level since the start of December 2021, while risk tolerance (green line) held on to the gains it has made since the start of the year. Despite last week’s rebound in risk aversion, net risk appetite remains fairly neutral, albeit still on the negative side, rendering emerging markets fairly safe from a downside overreaction to negative news in the short term. The return of Chinese investors this week should help to give it a more assertive direction.