by Olivier d'Assier
Potential triggers for sentiment this week1 :
- US: PPI, retail sales, housing starts, Fed’s interest rate decision.
- Europe: UK April GDP estimate, unemployment data, BoE interest rate decision.
- APAC: BoJ interest rate decision, China May industrial production.
- Global: Daily news flow out of Ukraine, geopolitics in the South Pacific, extreme weather events in the US and Europe, and food shortages – especially in emerging countries.
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:
- Sentiment continues to be poor or bearish among developed-markets investors, except in Japan, where the weak yen and dovish BoJ are underpinning a positive mood. Sentiment ended the week bullish in Asia ex-Japan and global emerging markets, and remained positive in China, where investors focus on efforts by authorities to get the world’s second largest economy growing again.
- Most markets we track are down around 10-15% year-to-date, having only narrowly avoided a bear market (defined as a 20% drop) in April. Last week’s concerted message to investors from central banks, the World Bank and the OECD was clear: “Help is not coming. Repeat: Help is not coming.” Dealing with inflation comes first, rescuing investors is a distant second.
- As hopes for an early end to the war in Ukraine fade, supply-chain pressures on everything from energy to food, is causing inflation to rise globally and continue its work of punishing investors. Central banks (with the exception of the BoJ) are hoping for a come-from-behind victory against rising prices but investors are wondering at what cost. For consumers, the pain is already real. For investors, not yet. But summer, with its low volumes, extreme weather events, and hypersensitive mood, is coming.
- Developed-market investors are turning increasingly negative on the outlook for the rest of the year, and with valuations still well above their historical median, they are implementing risk-averse strategies designed to protect from the downside. After the bear-market rally of late April and early May, momentum has returned for risk-averse assets. Value is getting expensive now, and investors are balking at the costs involved in making their portfolios look cheap.
- A negative risk appetite does not necessarily lead to a bear market, but it does increase the likelihood of overreactions to negative news. As we head into the summer months, given the current macro, geopolitical and climate changed situation, investors will need to be given more than just hope to become more risk-tolerant again.
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US investor sentiment
US investor sentiment (green line) continued to recover, ending the week negative (ROOF ratio below 0.0 but above -0.5, lhs in chart below) but no longer bearish (ROOF ratio below -0.5). The rebound in sentiment was triggered by assurances from the Federal Reserve in May that it was only targeting 50 bps rate increases at its June and July meetings, and not 75 bps as investors feared. After last Friday’s higher-than-expected May CPI numbers, investors may again need to be cajoled into believing in the Fed’s gradual approach to higher interest rates for the recovery in sentiment to retain its momentum. The level of risk-aversion remains higher than the level of risk-tolerance, and, as it did in late April, could surge again if this week’s PPI data is worse than expected. As we head into the summer months, the prospect of seasonally low volume and higher volatility, especially in the face of ongoing macroeconomic and geopolitical uncertainty, is likely to keep most investors on the sidelines.
European investor sentiment
European investors’ sentiment (green line) ended the week negative, almost unchanged from the previous week. Sentiment has declined since mid-May, but stopped short of becoming bearish last week on assurances that the ECB was only targeting a 25 bps rate hike at its next meeting. Still, the negative economic outlook depicted by the World Bank and the OECD for Europe last week could lead to further unwinding of the risk-tolerant positions built up by investors in late April and early May. The BoE’s rate decision this week could set the mood for European investors and reverse the recent decline in risk-aversion levels. At current levels, sentiment is still negative and risk appetite almost neutral, but the bias is still on the downside, with investors more likely to react to negative news than to positive news.
Global developed markets investor sentiment
Sentiment among global developed-markets investors (green line) ended the week bearish for the third week in a row. In addition to domestic fears about the impact of inflation and higher interest rates on the economy, investors must deal with higher-than expected currency volatility caused by the dislocation in monetary policies across major central banks. The uncertainty of the summer months is also helping risk-aversion levels to remain on an uptrend while risk-tolerance levels remain subdued near their recent lows. The imbalance between the potential supply and demand for risk assets is now wide enough to create a large overreaction to negative news, causing a sharp market correction in the process. The lower market volumes of the summer months will not help this situation either, or possibly add to the volatility investors will have to deal with. Absent a more convincing and sustainable recovery in sentiment, any market rallies are likely to be short-lived.
Asia ex-Japan markets investor sentiment
Sentiment among Asia ex-Japan investors (green line) surged last week, ending bullish for the first time since November 2021. The recovery in sentiment is linked to the broad reopening of economies in the region, the resumption of cross-border travel and plans by the Chinese authorities to stimulate their economy back to full growth. Low valuations for regional equities is also helping risk-tolerance, but we note that risk-aversion levels have remained on an uptrend since May and could stage a return to their March highs if another round of social distancing measures are announced following a recent uptick in new infections in Beijing. Another factor keeping some investors on the sidelines is renewed geopolitical tensions between the US and China, as well as a resumption of nuclear testing announced by North Korea, which is putting South Korea on the defensive.
Global emerging markets investor sentiment
Sentiment among global emerging-markets investors (green line) ended the week bullish and at its highest level since November 2021. The macroeconomic picture remains very negative for emerging economies, which is keeping market valuations low, but the hope for both fiscal and monetary stimulus out of China is lifting sentiment and driving risk-tolerance to its highest levels in seven months. Risk-aversion remains subdued but off its lows reached last April. In the current conditions, investors seem more likely to overreact to positive news in this region than to negative news. The question remains, where could positive news come from?
Japan market investor sentiment
Sentiment among Japanese investors (green line) ended the week sharply higher, just shy of bullish. The recovery in sentiment which started in late March with the weakening of the Japanese yen, has so far failed to end the week bullish, but insistence from the BoJ that monetary policy will remain accommodative and that inflation will not hurt consumers, lifted sentiment last week. The Japanese central bank is the only remaining major monetary authority not to see the recent rise in inflation as a negative for its economy and remains convinced it does not need to act. This has led to a sharp weakening of the yen against the US dollar, which in turn will make Japanese companies’ overseas earnings higher when translated into the local currency. Despite this scenario, risk-aversion remains on an uptrend amid anecdotal evidence that Japanese consumers are being hurt by the current level of inflation. There is a feeling by some investors that Governor Kuroda is playing chicken with inflation and risking consumer confidence in the process. But, for now, if sentiment remains positive, and consumers continue to spend during the summer months, the recent recovery could be sustainable a while longer, but not in the face of sharp declines in other developed markets. Risk appetite is not as strong as it should be to ignore losses across other major markets if they happen.
China (domestic) investor sentiment2
Sentiment (green line) among Chinese (A-shares) investors remained positive last week but failed to make any advances from the previous week. This despite continued talks of fiscal and monetary stimulus to get the domestic economy to recover from lockdowns in April and May. Reports of rising new cases of COVID-19 in Beijing and an increase in mandatory testing in Shanghai during the week unnerved investors and led to a rush of panic buying at local supermarkets. This highlights the ongoing impact of the governments zero-COVID policy on investors and the risk premium that a still fluid health situation is having on sentiment. Risk aversion and risk tolerance are evenly matched right now among Chinese investors, which should result in a calmer market environment in the short term. In the medium- to long-term, investor sentiment will continue to be swayed by the situation in Ukraine as well as the US-China relationship, both of which remain too uncertain to predict for investors.
2 Note that as of the end of May 2022, we have switched to using a core benchmark as estimation universe instead of the broad market portfolio to better capture the behavior of institutional investor by removing the small caps from our analysis.
