by Olivier d'Assier
Potential triggers for sentiment-driven market moves this week1:
- US: Services PMI, factory orders, balance-of-trade data.
- Europe: Eurozone retail sales, German industrial production.
- APAC: Reserve Bank of Australia (RBA) policy meeting, Australian Q1 GDP and services PMI; Chinese inflation and trade data.
- Global: Only a rapid escalation of hostilities in Ukraine appears as a key potential disruption for markets this week.
Insights from last week’s changes in investor sentiment:
Investor sentiment continued to improve in most markets after the US government narrowly avoided defaulting on its debt. The only two exceptions were Australia and Japan, where sentiment declined, and the US, where it remained neutral and unchanged from the previous week. Investors ended last week in a bullish mood in six out of ten markets we follow, with demand for risk far exceeding supply, indicating that further upside is likely in the short term. In the US, despite a resolution to the debt ceiling crisis and a stronger-than-expected jobs report on Friday, investors remained unconvinced that the economy is out of the recession woods yet and maintained their neutral stance.
With the threat of a US default behind us, it’s back to the chicken-and-egg guessing game between a resilient economy and monetary policy: Will a strong economy force central banks to keep raising interest rates, or will high interest rates force the economy to fall into recession? Risk-tolerant investors are focused on the defiance of the economy while risk-averse investors are focused on the consequences of higher interest rates. Unfortunately for the latter, markets have decided that for now, the chicken happens to taste better.
The resistance of equities during the US debt ceiling crisis is indicative of a market where, as low volumes suggest, most risk-averse investors have already migrated to other asset classes, leaving risk-tolerant investors in control. The latter have thrice now (Jul-Aug 2022, Oct-Nov 2022, Jan 2023) tried to engineer a pivot rally to lure risk-averse investors back, only to see them run out again each time stronger-than-expected economic data spooked them. Last Friday’s bullish response to the strong jobs report may be their fourth attempt at convincing risk-averse investors that there is nothing but rewards ahead. The trap looks good. It is well lit. It welcomes them in.
This week is a quiet one as far as economic and corporate data releases are concerned. The only wild card is geopolitics, but investors tend to react to those events rather than try to anticipate them. Most active market participants today are risk-tolerant and are taunting risk-averse investors sitting on the sidelines with positive returns and “the early bird gets the worm” investment advice. For now, the latter aren’t convinced and seem to be saying, “the early bird gets the worm, sure enough, but the second mouse gets the cheese.”
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). In between those two lines, 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.
Jump to a specific market
Asia ex-Japan:
Australia:
China:
Developed markets:
Developed markets ex-US:
Emerging markets:
Europe:
Japan:
UK:
US:
1 If sentiment is bearish/bullish, a negative/positive surprise on these data releases could trigger an overreaction.
