by Olivier d'Assier
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Potential triggers for sentiment-driven market moves this week1:
- US: FOMC minutes, durable goods orders, services, and manufacturing PMI data. Earnings from Zoom, NVIDIA, Dell, HP, and Best Buy.
- Europe: Services and manufacturing PMI data for the Eurozone and the UK.
- APAC: Services and manufacturing PMI for Japan, and PBoC loan prime rate decision in China.
- Global: Ongoing developments in the Israel-Hamas war, and minutes of both the ECB and Federal Reserve interest rate setting meetings, last week.
Insights from last week’s changes in investor sentiment:
Investor sentiment improved markedly last week with only two markets (Asia ex-Japan and Europe) out of seven previously, unable to complete their recovery on time and ending the week still bearish. Sentiment inGlobal developed markets, global developed ex-US markets, global emerging markets, Japan, and the US rose from their bearish levels in the previous week to end last week still negative but seemingly on a strong recovery path. China remains the only market with a bullish sentiment but the lack of a credible stimulus package, a sputtering economic recovery, and ongoing worries about the potential for more credit defaults in the property sector, is preventing a higher willingness to speculate from being rewarded with higher returns. This, despite improving US-China relations after last week’s Biden-Xi meeting. Sentiment in Australia and the UK remained neutral, virtually unchanged from the previous week, and still lacking in direction.
The key drivers of improved sentiment included a better-than expected Q3 earnings season, declining inflation, a softening job market, and the third consecutive decision by both the Fed and the ECB to hold rates where they are. Signs that the economy is starting to soften under the strain of previous interest rate hikes are also helping investors forecast a more rapid pace of decline for inflation and an earlier pivot by central banks. Additionally, geopolitical risks showed a slight improvement last week with ongoing hostage negotiations in Gaza and the reopening of direct communication between the US and China. Both served to lower market risk, as well as spur interest rate traders to bring forward their forecast for a rate cut at the Fed’s May meeting instead of at its June meeting just a month ago.
US investors have been discussing and anticipating a Fed pivot since August 2022, in the belief that a tide generated by lower interest rates would lift all stocks. Most stocks. Some stocks. Seven stocks. Last week was the first time that the rally extended to more than 60% of benchmark constituents since late July. The broadening of the market’s rally beyond the Magnificent Seven, will be welcome news for active managers, and is another sign that confidence is returning and helping sentiment recover faster.
The apparent removal of some of the macro and geopolitical risks last week seem to have lifted investor sentiment from its lows of “higher-for-longer” previously, to a new “high-for-not-much-longer” anticipation now. Look to average daily volumes for signs that this new thesis is becoming consensus.
Some risks remain, however. We still have two wars, establishment politicians keep getting replaced by populist newcomers, and the checks-and-balances usually provided by a divided government (a Congress of one party and a White House of another), seem more like blocking-and-tackling under the stress of extreme partisanship. So, even if the economy and regulators have investors’ back, political leaders could still let them down. But for now, given the continued low volatility regime, investors are likely to feel that the rewards are worth the risks.
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). Around the horizontal grey line at 0.0 (left axis), 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.
