by Olivier d'Assier
Potential triggers for sentiment this week1 :
- US Q2 earnings season continues with Apple, Facebook, Microsoft, Alphabet and Amazon
- US Q2 GDP first estimate, durable goods orders, and personal income and outlays
- Eurozone GDP and inflation
- US Federal Reserve rate decision and press conference
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:
- Investors remain worried that the combination of inflationary pressures and COVID-19 variants will cancel the happy ending for the economy that markets have been hoping for.
- Sentiment remains neutral in most major markets. At these levels, investors have not yet turned pessimistic but are increasingly anxious that things may not turn out as they had hoped.
- Economic data releases still point to a strong economy, central banks remain accommodative, the (US) Q2 earnings season thus far is one of the strongest on record, and domestic politics and geopolitics have been stable. Given this background, the argument for a weak sentiment isn’t necessarily logical but more likely emotional. Not logos but pathos.
- In this conflicted emotional state, investors tend not to blindly believe every official forecast about the economy as if they were some Lutheran creeds pinned to their door. Trust has an emotional component — it is sentiment disguised; and the latter is becoming increasingly fragile.
- A strong economy, rising inflation, stimulative monetary and fiscal policies, these are all things investors wanted last year. As the saying goes: after you get what you want, you don’t want it anymore, and when you get what you want, you no longer want what you get.
- Central banks and governments have given investors the gift of economic recovery, but, like any good gift, the less strings we find attached to it the better. investors now fear that inflation may only be the first string.
US investor sentiment:
US investor sentiment remains conflicted, wanting to believe in the strength of the economic recovery, but also half fearful of it. This week has some corporate heavy-weights reporting Q2 earnings and investors will pay close attention to comments and guidance from CEOs on everything from inflation, supply chain bottlenecks, US-China relations, and potential risks from COVID-19 variants. It may be time to feed investors’ emotional needs as well as their logical ones. At these valuation levels, a fragile sentiment is a big liability for markets.
Risk aversion (red line) continued to rise last week while risk tolerance (green line) headed lower. The two are now at equilibrium, resulting in a neutral risk appetite. This lack of sentimental direction occurred in February this year and resulted in a mostly flat market for the month. At equilibrium, the demand and supply for risk are evenly matched and unable to push or pull market prices up or down significantly, leaving markets to trade in a tight range.
European investor sentiment:
European investor sentiment (green line) continued to decline last week, ending in the middle of the neutral zone. As we have mentioned in past reports, the rise in sentiment in June and early July was mostly due to the declining market risk. When we compute our sentiment index without the influence of changing volatility (red dotted line) we see that investors were more cautious than it appeared. This lack of enthusiasm for risk-taking led to a mostly flat market during that period. Interestingly, the situation seems to have reversed with the recent rise in market volatility. The ROOF Ratio (including market risk – green line) continues to decline, but investors seem to be willing to buy more risk-tolerant sectors than in the prior month (red dotted line). Both indicators ended last week in the middle of the neutral zone, unable to give markets direction, but the momentum seems to no longer be on the downside at least.
Risk aversion (red line) and risk tolerance (green line) are now at equilibrium, describing a very neutral risk appetite among European investors. As is the case with their US peers, there is continued uncertainty as to the potential negative impact the latest COVID-19 variant will have on regional economies. Regulators and central banks remain accommodative, preventing sentiment from declining further, but investors seem to require further reasons to buy, leaving markets dangerously vulnerable to excuses to sell.
Global developed markets investors sentiment:
Global investor sentiment remained fragile last week, ending in the bottom half of the neutral zone for the second week in a row. At these levels, investors are not yet bearish but are increasingly growing anxious over the data they see and begin to question their willingness to keep buying at these lofty valuation levels. Market risk remains below last February’s levels, which is keeping sentiment above the bearish zone for now, but a negative outcome to the ongoing ‘return-to-normal’ experiment in the UK, as well as rising new infections from the new Delta variant, could push volatility back up and global sentiment down.
Risk tolerance (green line) halted its decline last week but remains below the risk aversion (red line) level. At these levels, the bias is still on the risk aversion side, but the momentum switched to a more neutral stance last week. Risk appetite may remain in this equilibrium state for some time, as it did in April and May, until the uncertainty about the impact of recent COVID-19 variants on the economic recovery becomes clearer.
Asia ex-Japan investor sentiment:
Investor sentiment in Asia ex-Japan continued to retreat last week dropping further into neutral territory. Renewed local lockdowns, the cancellation of travel bubbles, and continued regulatory risks in China weighed on sentiments and markets. Valuations in this part of the world remain well below their previous highwater mark reached in February and sentiment remains cautiously optimistic given the positive economic growth picture out of the US and Europe. If sentiment remains at this level, the bias is still on the upside and positive news could trigger a return to the bullish zone for both sentiment and markets.
Risk tolerance (green line) remained above risk aversion (red line) last week, signaling that investors’ risk appetite continues to be more positive than negative (i.e., they only need a small excuse to buy but will need a good reason to sell). An excuse to buy could come from the slew of earnings reports out of the US this week, while a reason to sell could come from the Fed’s interest rate decision and press conference. Investors are also watching the developments on the mainland for clues on ongoing regulatory changes as well as the US-China diplomatic exchanges for signs of renewed tension or cooperation.
