by Olivier d'Assier
Potential triggers for sentiment-driven market moves this week1:
- US: Manufacturing PMI, new home sales, durable goods orders data. FOMC meeting and interest rate decision (+25 bps expected).
- Europe: UK inflation report, Eurozone PMI; Bank of England interest rate decision (+25 bps expected).
- APAC: Bank of China prime rate decision (no change expected), Bank of Japan’s economic survey results, Australia’s PMI.
- Global: Investors will monitor the banking sector for signs that measures taken so far have succeeded in preventing further risk contagion.
Insights from last week’s changes in investor sentiment:
Investor sentiment continued to worsen in every market we follow last week. The mood weakened even in markets where central banks are being openly stimulative (Japan and China). The rescue of Credit Suisse by UBS over the weekend will provide some relief for investors, although the bargain price may be used by some to mark down the value of other banks with active investment banking operations. This week, focus will turn to the interest rate decision by the Federal Reserve and the Bank of England. Market participants expect a 25bps rise in both cases and anything that deviates from this expectation will be interpreted in the context of a declining sentiment and increasingly nervous investors.
Banks have a social network problem. Rumors of contagion from the Silicon Valley Bank (SVB) failure are being spread at lightning speed on social media platforms and private chat groups — home of the ‘he said, she said, Bill said, Monica said’ dialogue attribution. At issue is whether the SVB rescue package was simply a licked regulatory forefinger held up to test a wind already blowing across the entire banking sector. The cause of SVB’s collapse — and that of Signature Bank — is well known by now: the value of treasury bonds bought during the years of easy money has dropped sharply amid abrupt monetary tightening. If sold today, they no longer cover the value of deposits, leaving banks with this exposure vulnerable to an old-fashion run on the bank.
President Biden has told American depositors not to worry, that their deposits and the banking sector are safe. The ends of regulatory interventions do not change, much. Only the means do. Regulators refuse to call the rescue of SVB a bailout, arguing that they are just guaranteeing the deposits and that investors in the bank’s stock and bonds will face losses on their own. The problem with rescuing people from every kind of dangerous situation is that they stop believing that risk exists and only the fear of extreme risks can make them act prudently.
To recap the events of the past two months: Investors braced for economic pain from last year’s monetary tightening, but now realize the pain might be coming from somewhere else, a place they had not expected. Interest rates, the cause of the pain, are set to keep climbing; the geopolitical outlook is worsening; US politicians are already pitching the tent for next year’s presidential election circus; and the lesson from the UBS takeover of Credit Suisse seems to be that value is no longer measured by real worth, but by lack of it. Uncertainty remains high, volatility keeps rising, investor sentiment continues to weaken, and fear of missing out is no longer supporting equity markets. So, before you consider buying more risk assets, to quote ABBA, “La question c’est voulez-vous?“.
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.
