Potential triggers for sentiment-driven market moves this week1:
- US: A huge week for markets, with the Fed’s interest rate decision (+25bps expected), advanced Q2 GDP estimates, personal consumption, durable goods orders, PMI data and the PCE price index. Also on the docket this week, are earnings reports from major tech companies Alphabet, Microsoft, Meta, Intel, Amazon, and Spotify Technology, as well major consumer companies General Motors, Snap, Visa, Coca-Cola, Mastercard, McDonald’s, Ford Motor, Intel, Chevron, Exxon Mobil, and Procter & Gamble. Other big names include telecom giants AT&T and Verizon.
- Europe: ECB interest rate decision (+25bps expected), and forward guidance. Flash PMI data for the Eurozone.
- APAC: BoJ interest rate decision (no change expected) and PMI data for July. In China the Communist Party’s Politburo is likely to meet and discuss plans aiming to boost economic recovery. In Australia, second-quarter inflation rate, July PMI figures and June retail sales data are expected.
- Global: Investors will focus on interest rate decisions in the US, Europe, Japan, and Australia. Barring any monetary policy surprises in the US, earnings will dictate the direction of sentiment, as investors focus on forward guidance and profit margins.
Insights from last week’s changes in investor sentiment:
Investor sentiment continued to weaken last week in all markets we follow except China, where it recovered from bearish to neutral following repeated talks of upcoming stimulus. The recent decline in sentiment is limiting gains in some markets (Asia ex-Japan, Australia, China, Global Emerging markets, Europe, and Japan), and keeping them range-bound for the time being.
In others (Global Developed and Global Developed ex-US markets), the recent dissonance between markets and sentiment is unsustainable and given the current imbalance between the demand for and potential supply of risk assets in those markets, a downside overreaction is highly likely in the event of negative news on the aforementioned triggers. Sentiment is currently negative in the UK but the market there is well below its February high-water mark. And in the US, sentiment has only weakened to neutral from bullish earlier this month, keeping the potential supply and demand for risk assets balanced for now.
Investors are anxiously hoping this week will be the season finale of Stress in the City. The Bulls are looking for confirmation that we have reached the peak of the interest rate cycle in the US and Europe, that Q2 earnings aren’t as bad as feared (-7.1% for S&P500 companies according to FactSet), and that consumers aren’t threatening profit margins with demands for big price discounts (e.g. Netflix and Tesla), or they’ll stop buying. As for the Bears, most of whom are still looking in from the bleachers, they know that feeling good about inflation is like looking on the bright side of an unpaid vacation bill. When you quit looking on the bright side , the bill still needs to be paid. When you quit looking at the downward path of inflation, the high interest rates are still there and still rising.
Investing isn’t just about answering the right questions, it’s also about answering the follow-up questions. Once you’ve answered when interest rates will stop rising, you still need to answer the questions about when they will start falling again and how much damage will have been done to the economy between now and then. Are we looking at a repeat of the prolonged period (from July 2006 to June 2007) of high (US) interest rates which caused the extended (December 2007 to May 2009) recession, or are we looking at a short-term soft landing, swiftly followed by a stimulative monetary policy? The message from the Bears here is that those who fail to learn from history usually don’t do so well on the stock market.
A big piece of the investment puzzle will be released (and answered) this week: How close are we to the peak of the interest rate cycle? For the Bulls and the pivot hopefuls, monetary policy helps explain everything. There is a sense that once interest rates have peaked, something wonderful will happen, though, as is common with all utopian theories, a detailed map of utopia is not included in the plan. We are probably closer to the peak of the interest rate cycle than the trough, but we may still be some way from the trough of the earnings cycle; a position not yet reflected in either equity valuations or credit spreads among the high-yield segment of the corporate bond market.
That said, of the uncertainty trifecta of interest rates, economic growth, and earnings, only the first may be confidently answered this week. The latter two will continue to weigh on sentiment as follow-up questions that must be answered.
Changes to investor sentiment over the past 180 days for the markets we follow:
How to read these charts: 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 (-0.2 to -0.5) and a bearish one (<-0.5), and the horizontal blue line at +0.5 (left axis) represents the frontier between a positive sentiment (+0.2 to +0.5) and a bullish one (>+0.5). Around the horizontal grey line at 0.0 (left axis), sentiment can be considered neutral (-0.2 to +0.2).
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. When risk tolerance (green line) is higher than risk aversion (red line), there are more investors looking to buy risk assets then investors willing to sell them (at the current price), forcing risk-tolerant investors to offer a premium to entice more risk-averse counterparts to take the other side of their trade, which drives markets up. The reverse is true when risk aversion (red line) is higher than risk tolerance (green line). The net balance between risk tolerance and risk aversion levels is used to compute the ROOF ratio in the top charts, representing the sentiment of the average investor in the market.
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.
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Developed markets ex-US:
1 If sentiment is bearish/bullish, a negative/positive surprise on these data releases could trigger an overreaction.