by Olivier d'Assier
Potential triggers for sentiment-driven market moves this week1:
- US: Debt ceiling negotiations, FOMC meeting minutes, speeches by several Fed officials. Personal income and spending data for April, PCE prices, second estimate of Q1 GDP, durable goods orders, services and manufacturing PMI data.
- Europe: UK inflation data, Eurozone and UK PMI.
- APAC: Japan PMI, Bank of China interest rate decision.
- Global: US debt ceiling negotiations, a deteriorating US-China relationship after this weekend’s G-7 meeting in Tokyo, as well as further escalations in the war in Ukraine.
Insights from last week’s changes in investor sentiment:
Investor sentiment continued to improve globally in the past two weeks, completing its recovery from the lows reached during the US banking crisis in March. Investors in Global Developed and Global Developed ex-US markets have become bullish for the first time since February, while the highly politicized US debt ceiling negotiations have kept sentiment there from rising beyond positive, despite a better-than-feared earnings reporting season. Sentiment among UK investors also improved sharply last week, catching up with recent market performance. Elsewhere, sentiment remains neutral, with investors awaiting clarity on the direction of monetary policy and confirmation on whether the much-anticipated global economic slowdown has been once again postponed, or possibly cancelled.
The Q1 (US) earnings reporting season did what it was supposed to do, which is to distract investors from the macro and geopolitical conundrums driving uncertainty by inundating them with advice on stocks they have to buy, companies they must own, and deals they can’t miss. During the past four weeks, stocks were subjected to a constant Yelp review where every analyst had thoughts on how investors’ portfolios could be improved by focusing on the who’s who, and the what’s what of the corporate world. Back in March, Q1 earnings were expected to fall by 6.7%, and have ended up declining by 2.2%, according to FactSet. In the past, ‘not-as-bad-as-feared‘ would have sent the market up 10%, but investors really have to be in the mood for that, and right now, US investors are barely lukewarm.
With the earnings reporting season now behind us, focus will turn to political, geopolitical and macroeconomic news. Since 1960, the US congress has experimented — and failed — with balancing the budget so frequently and consistently (78 times!) that they should really apply for government funding. To say that a US default is bad news for markets would be the biggest understatement since the captain of the Hindenburg said, “I smell gas” (cliché, I’m aware). Adding to investors’ concerns, is the rapid deterioration in the US-China relationship. This weekend’s G-7 meeting in Tokyo has reinforced the urgency behind the switch from ‘just-in-time’ to ‘just-in-case’ supply-chain management. Loading up on China-linked stocks after that is like stopping to grab a bacon double cheeseburger on your way to the hospital right after experiencing chest pains because you know once you get there, they’ll never let you have it again.
Markets and sentiment have recovered globally since mid-March, but this recovery has been driven by declining volatility and a continued preference for highly liquid, large and profitable companies with a well-diversified revenue base (away from China) and no (or little) debt. Gone (for now) are the days when profitability was seen as an unfair advantage and size didn’t matter. As to the potential for a monetary pivot by major central banks as early as next month on the back of these macro concerns, optics are important, especially in the world of believing in something you’re trying not to be skeptical about.
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.
