Potential triggers for sentiment this week1 :
- US: March jobs report and personal consumption expenditures data.
- Europe: Inflation and consumption data for the Eurozone and the UK.
- APAC: PMI data for China and Japan, industrial production for Japan.
- Globally: The ongoing conflict in Ukraine, and the evolving COVID-19 situation across Europe and Asia, will continue to dictate investor sentiment.
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
- Investor sentiment remains deeply bearish in all markets we track except China (domestic), where it recovered slightly on the back of heavy verbal support from key regulators in the last two weeks. Failure to reach a truce in Ukraine as well as the lack of March data to ascertain the conflict’s impact on the global economy is keeping investors on the defensive for now.
- During his European tour, President Biden appeared to call for Russian President Putin’s ouster. The White House later said he was not pushing for regime change in Russia. Now, the average investor knows even less about Freud than I do, which is little, but they know a Freudian slip when they hear one. A diplomatic end to sanctions now seems a long way off.
- Simultaneously, tensions between the US and China rose last week after Chinese officials accused the US of ongoing efforts to create a NATO-like block in Asia and threatened “unimaginable” consequences if it continued what it called a policy as “dangerous as the NATO strategy of eastward expansion in Europe”.
- If the invasion of Ukraine marks the start of Cold War II, with more conflicts to come, then it seems that the two sides have chosen a new military doctrine. The first Cold War relied on a theory of deterrence called M.A.D. (mutually assured destruction), the new Cold War between East and West seems to rely on M.A.E.D. (mutually assured economic destruction). Both the IMF and the Institute of International Finance have warned of a deep recession in Russia, with the latter predicting that sanctions will wipe out 15 years of the country’s economic expansion.
- While Russia may not be capable of inflicting reciprocal damage to Western economies, China, as the world’s second largest economy, certainly could. Investors got their first taste of this new world order during the 2018 US-China trade war, and at the time, they found a way to eventually deal with it. They will need to dust off that playbook if tensions between the two economic powerhouses continue to escalate.
- Conversely, a warming of this relationship would further isolate Russia and align China with the Western world in its efforts to rebuild Ukraine and the world economic growth, triggering a sustainable long-term bull market. If wishing only made it so…
US investor sentiment
US investor sentiment (green line) continued to recover since a lower-than-feared interest rate hike three weeks ago, but remains bearish. The recovery is significant and has been supportive of the recent market rebound — however it is still fragile and hostage to ongoing developments in Ukraine. In the last month, the West has moved from threatening sanctions to implementing them, and now to enforcing them. No economic data has yet been released on their impact on the US or global economies, keeping investors on the defensive despite more attractive valuations. At this time, both markets and sentiment look like they may have hit a bottom in mid-March, but the binary nature of the war in Ukraine, and the possible second geopolitical tension front with China, is not giving investors the confidence they need to become more risk-tolerant in the short term.
Risk aversion (red line) and risk tolerance (green line) continued to converge last week but remain wide apart, with the supply of risk far outstripping demand. Despite the recent improvement, risk appetite remains more negative than it was all of last year and it will take a few more weeks like the last one to get rid of this imbalance. For now, risk aversion is still the dominant sentiment.
European investor sentiment
European investors’ sentiment (green line) ended last week bearish and at its lowest level since the war in Ukraine begun. Market risk wasn’t a major factor as even sector allocation alone (red dotted line) pointed to the implementation of increasingly risk-averse strategies. NATO displayed a united front during the threat and implementation of economic sanctions against Russia, but some member countries will find it more difficult to remain aligned during the enforcement phase due to their over-reliance on Russia for both coal and natural gas (both over 40% of imports). Investor sentiment is likely to remain under pressure until this supply-chain puzzle has been resolved. Meanwhile, the focus will be on inflation figures due out this week.
Risk-aversion (red line) rose sharply last week as the civilian toll from the war in Ukraine continued to escalate. Risk tolerance (green line) halted its rebound from the previous week and ended the week near its 2021 lows. Developments in Ukraine will continue to weigh heavily on European investors’ risk appetite in the short term, and economic data releases in the coming weeks could increase their risk-aversion levels, making them more prone to downside overreactions to negative news.
Global developed markets investors sentiment
Sentiment among global developed-markets investors (green line) continued to decline sharply, ending last week at its most bearish level since the war in Ukraine started. Hopes for a quick resolution have now faded and investors are becoming increasingly negative about the short-term prospect for the global economy. International regulators are already warning about the economic impact on both global trade as well as emerging-market economies, which are already feeling the stress of inflationary pressures. The lack of economic data since the war started along with the volatile COVID-19 situation in Europe is also weighing on sentiment.
Risk tolerance (green line) continued to decline last week, while risk aversion (red line) rose sharply. The net risk appetite is now very negative with more than two potential sellers (risk-averse investors) for every potential buyer (risk-tolerant investors). In this imbalance, any negative news can trigger a sharp downside overreaction.
Asia ex-Japan markets investor sentiment
Sentiment among Asia ex-Japan investors (green line), fell to its lowest level in over eight months on deteriorating US-China relations. A series of speeches by both sides increased fears that the relationship between the two largest economies in the world is becoming increasingly confrontational. Both governments are now actively trying to decouple their economies and financial markets from one another, leaving investors highly uncertain as to how this will end. Who will take the first step in deescalating tensions and removing this threat on global trade?
Risk tolerance (green line) remained flat last week while risk aversion (red line) edged. There are now more than two potential sellers for each potential buyer in the market. Geopolitical tensions at home and abroad are keeping regional investors on edge, despite supportive measures by Chinese regulators locally. Both sides, the US and China, will need to convince investors that the war in Ukraine will not have lasting consequences on global trade.
Global emerging markets investor sentiment
Sentiment among global emerging-markets investors (green line) seesawed last week, ending bearish but off its new 12-month low reached earlier in the week. Emerging economies remain highly sensitive to commodity prices, which have risen due to the Russia-Ukraine conflict. Higher commodity prices, a stronger dollar and rising US interest rates are a triple negative for emerging economies. Clearly, for emerging market investors, the sooner this war ends, the better. Until then, it seems they will remain risk-averse.
The gap between risk aversion (red line) and risk tolerance (green line) ended last week a bit smaller than it started it but remains too large for any rally to be sustainable. The military conflict in Ukraine has made the US market the safe haven and international fund flows have overwhelmingly moved there from both emerging markets and even European ones. Only an end to the war will bring them back. Until then, risk appetite will remain very negative.