by Olivier d'Assier
Potential triggers for sentiment this week1 :
- US: FOMC minutes, consumer sentiment survey, durable goods orders and new home sales.
- Europe: ECB monetary policy accounts, Eurozone PMI.
- APAC: China PBoC interest rate decision, Japan PMI.
- Global: Any nuclear (power plant or weapons) developments from the war in Ukraine, and any renewed COVID-19 lockdowns in China, resulting in further downgrades for global growth.
Summary of changes in investor sentiment from the previous week:
- Investor sentiment ended little changed from the previous week, signalling a pause in the recent recovery from a bearish sentiment in October. Investors in developed Europe, global emerging markets and Japan remained neutral; those in the US and Asia ex-Japan stayed negative (the latter, very much so); and investors in China were still bearish in response to fears of COVID-19 lockdowns.
- The stock market is both flexible and reflexive. It is flexible because the data can be interpreted differently by different investors, and it is reflexive because the aggregation of these forecasts is what dictates market returns. The problem for most investors is that forecasting requires too many assumptions right now to give them the confidence they need to make a strong bet on the direction of markets.
- US voters erected a seawall during the Midterm elections, transforming a potentially contentious red wave into Lake Flaccid. The loss by three election-denier candidates for Governorship handpicked by former President Trump (Mastriano, Dixon, and Lake) signals that ‘stop the steal!’ may be a dead-end strategy with voters in 2024. This opens the field for the Republican nomination with a flurry of ‘I’m not Trump!’ candidacies. The field might be similarly open for the Democrat nomination if President Biden’s age becomes an issue with voters2. A weakly divided government and unknown candidates for 2024 is likely to add a layer of legislative uncertainty on top of the existing macro and geopolitical ones.
- Investors face an unclear macroeconomic future, a set of impossible-to-predict binary geopolitical situations (Ukraine, US-China, Iran, North Korea…), and a coalition of hawkish central banks. The latter is providing the only certainty (that interest rates will keep rising) in this otherwise very uncertain environment, which should keep sentiment on the neutral-to-negative side of the ledger in the near term, and most investors on the sidelines.
Jump to a specific market
US investor sentiment
Sentiment among US investors (green line) failed to build on its recent recovery, ending the week negative and slightly lower than the previous week. The lower CPI and PPI data were not enough to convince investors that the Federal Reserve would pivot to a less restrictive monetary policy any time soon. Speeches by several central bank officials also seemed to make clear that interest rates would keep rising, even if at a slower pace, for the foreseeable future. This week’s FOMC minutes should also reinforce that message, as it did on August 26, putting the final nail in the Pivot thesis’ coffin. November has so far produced only less-than-feared facts, which is not enough to affect the stagflation consensus forecast investors are still implementing. Investors remain more risk-averse than risk-tolerant and saw nothing in the recent data releases to make them change their mind.
European investor sentiment
European investors’ sentiment (green line) ended the week neutral and little changed from the previous week. The key driver for the recent improvement in sentiment has been almost exclusively a drop in market volatility, as investors continue to implement a mostly risk-averse sector allocation. Details on the ECB’s last meeting will be released this week and might help investors decide how much faith they should put into talks of a monetary policy pivot, if any. At this stage, sentiment suggests that investors are neither risk-tolerant nor risk-averse, but average traded volumes indicates that they do not feel confident enough to make an informed decision either way. As long as volatility remains below its September peak, investors will not need to de-risk their portfolios, and risky assets will hold on to recent gains, but more good news is needed for valuations to rise further given the uncertain environment.
Global developed markets investor sentiment
Sentiment among global developed-markets investors (green line) declined slowly last week, from neutral to negative, returning to its level of two weeks ago. Negative concerns about the global economy from potential COVID-19 lockdowns in China, outweighed the positives of lower market risk and currency volatility. Risk aversion rebounded and risk tolerance declined, turning a previously neutral risk appetite into a negative one by the end of the week. This ended a month-long recovery in sentiment that had seen investors go from bearish in October to neutral the previous week. As in other markets, average traded volumes remain well below their levels from the first half of the year and are indicative of investors’ lack of confidence in their forecasts for 2023. Until clarity returns to both the macroeconomic and geopolitical outlook, they are likely to refrain from making sustainable directional bets, leaving markets rudderless.
Asia ex-Japan markets investor sentiment
Sentiment among Asia ex-Japan investors (green line) ended the week strongly negative, unchanged from the prior week. In addition to concerns about the impact on the global economy from a prolonged period of high inflation and high interest rates, investors are also concerned about the possibility of COVID-19 lockdowns in China over the winter months as the number of new infection surges in major cities. Supply-chain disruptions from lockdowns would not only hurt Chinese manufacturers but regional ones as well. Market valuations already reflect this negative outlook, even after the recent November rally, but the absence of positive news means investors will stay away instead of participating in bargain-hunting. Risk aversion remains well above risk tolerance, resulting in a negative risk appetite, and a better-safe-than-sorry approach to markets in the short-term.
Global emerging markets investor sentiment
Sentiment among global emerging-markets investors (green line) was unchanged last week, ending neutral and holding on to a recovery from its mid-October lows. The improved sentiment was driven exclusively by a decline in risk-aversion levels, in turn driven by the decline in market volatility since the end of October. This means that investors have not pivoted to a more risk-tolerant investment thesis but are simply reacting to changing risk levels by no longer having to de-risk their portfolios. Nothing has made them change their mind about the economic outlook, and stagflation remains the consensus outlook for them, which explains why risk tolerance levels remain low. This translates into a lack of support for higher valuations.
Japan market investor sentiment
Sentiment among Japanese investors (green line) continued to recover last week, ending neutral for the first time since early September. Interestingly, the recovery in both markets and sentiment was not matched by a more risk-tolerant sector allocation (red dotted line). As the only market we cover that saw a large rebound in average traded volumes in the past two months, we can conclude that Japanese investors have simply reached a stagflation scenario consensus later than investors in other markets, and that the current market rally was powered by a sharp increase in the demand for risk-averse assets rather than risk-tolerant ones. The red dotted line in the chart below represents the sentiment of investors absent the change in market risk. In other words, were it not for the sharp drop in volatility this month, sentiment (the green line) would mirror the red dotted line downward. Additionally, since investors continue to implement a risk-averse strategy, once they are done positioning their portfolios, the buying will stop and market prices will either stabilize at current levels or decline if market risk increases.
China (domestic) investor sentiment
Sentiment (green line) among Chinese (A-shares) investors remained bearish last week, ending only slightly higher than the previous week. The ongoing threat of COVID-19 lockdowns continues to overshadow the recent rescue efforts of the heavily indebted real-estate sector by the authorities. Average traded volumes have surged in November, driven almost entirely by demand for risk-averse assets, but remain well below the levels of the first half of 2022. Risk aversion is now much higher than risk tolerance among investors, increasing the probability of a downside overreaction in the case of a negative risk event. The negative risk appetite raises the stakes for this week’s Bank of China rate decision.
1 If sentiment is bearish/bullish, a negative/positive surprise on these data releases could trigger an overreaction.
2 Some 86% of Americans said they believe the cutoff for serving as president should be age 75 or younger, a recent Reuters/Ipsos poll found.
