Potential triggers for sentiment this week1 :
- US: industrial production, retail sales and earnings from big retailers, and Fed speeches.
- Europe: UK labor market report, inflation and retail sales release.
- APAC: Chinese industrial production and retail sales, and Japan’s GDP for Q3.
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 diverged further last week between investors in developed markets, who remain focused on supply issues and their associated inflationary impacts, and investors in emerging markets, who continue to bet on the post-pandemic surge in demand.
- Investors in the US and developed Europe are more positive than they appear, however, and have seen their confidence held back by rising market risk. Both groups have been implementing more risk-tolerant sector allocations recently, and were market risk to no longer act as a constraint, sentiment could recover rapidly as confidence returns.
- In contrast, investors in emerging markets appear less worried about market risk, and focused more on strong consumer demand abroad and low valuations at home. Experience has shown that those who pursue risk-on strategies in a mostly risk-off market are creating bad liabilities from the portfolio insurance point of view.
- The divergence in sentiment across markets can also be partly explained by the fact that developed-market investors have an above-average year-to-date (YTD) performance to protect, while emerging-market investors have nothing to lose by doubling down this late in a year of negative returns.
- There are no major geopolitical risk events in the schedule for the rest of the year and (developed-market) investors have implemented (and been rewarded for) mostly risk-off strategies all year. So, even if unexpected negative news was to hit the wires in the next six weeks, they seem well positioned to weather the storm without having much de-risking to do. Not so for emerging-market investors.
US investor sentiment:
US investors sentiment (green line) paused its recovery last week, ending just inside the neutral zone (between +0.5 and -0.5). Sentiment based solely on sector allocations (red dotted line) indicates a slightly more positive positioning by investors, whose confidence may simply be scaled back by seasonal factors. Year-to-date, market returns have been more than twice their long-term median but have so far rewarded risk-averse portfolios more than risk-tolerant ones, giving investors no incentive to change so close to the end-of-year performance reviews.
Risk aversion (red line) and risk tolerance (green line) remain far apart from each other with the potential supply of risk still dominating potential demand. The Q3 earnings season narrowed the gap between the two somewhat, but as macro news is set to dominate the front pages for the next two months, the currently net negative risk appetite should continue. Inflation has been the main concern for investors since February this year and this week’s series of speeches by Federal Reserve board members will be keenly watched for clues on the direction of monetary policy next year.
European investor sentiment:
European investor sentiment (green line) remained in the bearish zone (below -0.5) last week but did not fall further. European markets had got some support from the implementation of more risk-tolerant sector allocations (red dotted line) in the past few weeks, but the rise in market risk from the late September correction has unnerved investors and has kept sentiment negative since then. Unless sentiment recovers, it will be hard for investors to defend more bullish strategies this close to year-end performance reviews.
Risk aversion (red line) and risk tolerance (green line) remain far apart from each other, reflecting a dangerously low risk appetite by investors. European investors also have a better-than-average performance to protect going into the final month of the calendar year and with macro concerns still being top-of-mind, we’re unlikely to see a big recovery in risk appetite, unless further fiscal or monetary stimulus is announced.
Global developed markets investors sentiment:
Sentiment among global developed-markets investors (green line) continued to drift lower into the bearish zone last week, halting the recent market rise in the process. Sector allocations (red dotted line) also reflect a rather muted attitude towards risk-taking by global investors, typical of this time of year. The COVID-19 situation remains fluid and uneven across the world as we head into the winter months, and inflation concerns are preventing major central banks from being as accommodative as they have been in the past. The question for investors is, can the global economic recovery survive without further stimulus?
Risk tolerance (green line) and risk aversion (red line) diverged further last week, resulting in the second-weakest risk appetite score so far this year, following the lows of late August that preceded the September market corrections. With time running out for the year and risk-averse strategies outperforming risk-tolerant ones, investors do not seem to have the confidence required for a risk appetite pivot ahead of the holiday season.
Asia ex-Japan markets investor sentiment:
Sentiment (green line) among Asia ex-Japan investors continues to rise unabated, ending last week at the highest level this year. The current level reflects an overconfident bullishness that is only supported by low valuations and the current low interest rate environment. There is also a timing issue versus developed markets, with most Asian markets still facing some COVID-19 restrictions, leading to investors’ belief that the post-pandemic surge in demand in the region is still to come. The sector allocation (red dotted line) points to continued implementation of risk-on strategies by investors, despite negative cumulative year-to-date returns from the market. The only reason for this perseverance is the fact that risk-off strategies have feared even worse. “Not-as-bad”, however, should not be a long-term strategy.
Risk tolerance (green line) and risk aversion (red line) reached their YTD high and low, respectively, last week. With the end of the Q3 earnings season, any trigger for this strong risk appetite will have to come from the macro or geopolitical fronts (e.g., further trade agreements between the US and China?). Investors seem to be discounting the credit default risk out of China and focus instead on the low interest rate regime and the strong consumer demand from developed markets. Still, the level of hope in the current risk appetite levels is more indicative of faith than forecast.
Global emerging markets investor sentiment:
Global emerging-markets investor sentiment (green line) remained at their YTD high last week. Markets once again responded by rising sharply after hesitating the previous week. Investor sentiment has been mostly positive this year yet, but with YTD cumulative returns still in the red, markets have not rewarded risk-taking by investors. The most likely reason for this divergence is the absence of fund flows from developed-market investors, who have preferred domestic markets to emerging ones. Unlike after the global financial crisis (GFC), when emerging markets became the engine of growth for the global economy, the post-COVID-19 growth has been driven by developed economies and their investors have been rewarded for staying home instead of venturing into emerging markets. We see no reason for this to change in the short term.
Risk aversion (red line) and risk tolerance (green line) remain far apart, creating a net demand for risk among emerging-markets investors. Returns in emerging markets are hugely influenced by global fund flows. In this context, what the current strong risk appetite means is that emerging-market investors are expecting these flows to turn positive soon, but this could be a case of a short-term strategy becoming a long-term one through lack of performance. It also means that valuations for the more risk-tolerant sectors are becoming a little rich, and potentially unattractive for global developed-market investors if and when they decide to make the trip.