by Olivier d'Assier
Potential triggers for sentiment-driven market moves this week1:
- US: Fed interest rate decision (exp. +25 bps), January jobs figures, ongoing earnings reports.
- Europe: Bank of England (BoE) and ECB will announce their interest rate decision (exp. +50bps); inflation and GDP growth rates for major European economies including Germany, France and Italy.
- APAC: China manufacturing PMI data and Japanese consumer confidence index.
- Global: Baring any surprises from central banks’ interest rate announcements, corporate earnings and forward guidance will continue to take center stage.
Summary of changes in investor sentiment from the previous week:
Every week brings with it fresh signs that the global economy is slowing down, collateral damage from the ongoing fight between central banks and inflation. In the last ten days, investor sentiment has decided to focus on the only positive from this data, that inflation may have peaked and is decidedly on the retreat. Sentiment has risen from neutral at the start of the year, to end last week bullish in all markets we track except Europe, the UK and Japan, where sentiment remains neutral, but no longer negative.
The decision to buy or sell stocks is so individual and multifaceted that trying to explain it is a bit like trying to explain why people fall in love. What we’ve observed since the start of the year, however, is that risk tolerance among market participants has been consistently rising, together with falling market risk. Last year’s biggest losers have been this year’s biggest winners so far (e.g., Tesla), but the average traded volume among constituents of the most popular benchmarks remains well below levels seen in the first half of 2022. This suggests that the recent risk appetite and speculation about central banks’ pivot to a more accommodative monetary policy may be exclusively driven by gut feeling (or more accurately the emotional part of the brain we like to pretend is living in our tummies).
Even if this week’s interest rate decisions by major central banks matches expectations (i.e., +25 bps for the Fed, +50bps for the BoE and the ECB), the key for sentiment will be in the guidance behind these announcements, specifically central banks’ resolve in maintaining a high interest rate environment during all of 2023. Traders in both the interest rate derivatives and the bond market have priced in an 82% probability of the Fed cutting rates at least once before their December 2023 meeting. But, as the pivot hopeful learned (the hard way) last year in September and October, fighting the Fed is like fighting gravity, the best you can hope for is a draw.
If central banks stand firm in their resolve not to cut interest rates this year, despite a sharp economic slowdown, this will come as a real shock to bullish investors for whom the pivot thesis is their whole schtick. For the rest of investors, there remains too much uncertainty as to the direction of key variables for them to make a reliable forecast at this time. In the short term, sentiment bias continues to support higher market prices, but the bullish tone of markets is built on a minority opinion that could quickly unravel with a denial from central banks or a rapidly rising market risk. In short, we may be sitting on top of a sentiment bubble about to burst.
Changes to investor sentiment over the past 180 days for the markets we follow:
The following charts present data in the following structure: The top charts show the ROOF ratio (investor sentiment) in green (left axis), against the cumulative returns of the underlying market in black (right axis). The horizontal red line at -0.5 (left axis) represents the frontier between a negative sentiment and a bearish one, and the horizontal blue line at +0.5 (left axis) represents the frontier between a positive sentiment and a bullish tone. In between those two lines, sentiment can be considered neutral (0.2 to -0.2), with a positive (0.2 to 0.5) or negative (-0.2 to -0.5) bias.
The bottom charts show the levels of both risk tolerance (green line) and risk aversion (red line) in the market. These represent investors’ demand and supply for risk. The net balance between those two is used to compute the ROOF ratio in the top charts, representing overall investor sentiment.
The blue shaded zone between levels 3-4 for both indicators represents a reasonable balance between the supply and demand for risk in the market. Conversely, when both lines are outside of this blue zone, the large imbalance in the demand and supply for risk can lead to an overreaction to unexpected news or risk events.
Jump to a specific market
US:
Europe:
UK:
Developed markets:
Developed markets ex-US:
Asia ex-Japan:
Japan:
Australia:
China:
Emerging markets:
1 If sentiment is bearish/bullish, a negative/positive surprise on these data releases could trigger an overreaction.
