Potential triggers for sentiment this week1 :
- US: FOMC minutes, speeches from several Fed officials, inflation rate and retail sales data for September. Q3 earnings reporting season gets underway.
- Europe: UK unemployment, industrial production, GDP data.
- APAC: China inflation rate and trade figures.
- Global: Investors will look out for evidence if the global economy is heading for a prolonged period of stagflation. Focus also remains on the escalation of the war in Ukraine.
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 ended last week bearish in every market we track for the first time since March of this year. Note that China’s numbers are for the previous week due to the week-long market holiday. Investors in global developed, global emerging and Asia ex-Japan markets were the most bearish due to increased currency risk aversion from volatile exchange rates. Globally, investors have been implementing their stagflation base-case and downgrading the probability of a central bank pivot base-case.
- The previous week, investors worried higher interest rates would weaken the economy. Last week, they hoped a weaker economy would prevent higher interest rates. The reigning rule of the stock market is change — endless, sometimes predictable, at other times seemingly random, change. It was forever thus, and always will be. Case, far from closed, permanently open. And with uncertainty laying siege to markets on all sides, we better get used to it.
- The war in Ukraine continues to be unpredictable as to when or how it will end. Russian propaganda has its own meta language, a kind of mental uniform if you will, and Putin is very good at unbuttoning it. Investor sentiment will continue to be swayed by the narrative used by the Russian leader, especially with regards to the potential use of tactical nuclear weapons on the field.
- Thin volumes, high volatility and uncertainty, and a bearish sentiment globally means investors will overreact on the downside to any negative news. Several data releases this week could act as a trigger (FOMC minutes, inflation data and the first batch of corporate earnings), as could do further escalation in the war in Ukraine.
Jump to a specific market
US investor sentiment
Sentiment among US investors (green line) ended the week bearish for the first time since May. The rise and fall in both markets and sentiment this year reflects ongoing pricing of macro risks from both the hawkish monetary policy and ongoing geopolitical events, but what has probably not yet been priced in is a dip in corporate profits. Most earnings models have as input employment and consumer spending metrics — both of which have remained relatively strong so far. At this point, the bearish sentiment among investors reflects the fact that the probability for a negative earnings surprise outweighs the probability for a positive one. If the data confirms investors’ negative bias, they will overreact on the downside. Conversely, being bearish, they are unlikely to give positive earnings surprises much credibility. The negative balance between risk aversion and risk tolerance is not as bad as it was during Q1 of this year, and with volumes indicating that a lot of investors are sitting on the side lines, downside risk may not be as large as feared in the short term. A recovery, however, is unlikely to take place until sentiment becomes positive again.
European investor sentiment
European investors’ sentiment (green line) turned bearish for the first time since June on Friday last week, after being on a downtrend since early August. The macro stress on European economies from the war in Ukraine continues to weigh on investor sentiment and rattle markets. The best-case scenario of an early end to the war now has the lowest probability and investors are implementing risk-averse strategies linked to the base case of war lasting through the winter, resulting in energy shortages and economic stagflation. The only variables between the base case and the wort case, is a further escalation in Ukraine, deeper energy shortages resulting in social unrest, a new wave of COVID-19 infection necessitating the reimposition of social distancing measures over the holidays, and large negative earnings surprises. Sentiment remains well above its lows reached in February of this year, indicating that the worst-case scenario has not yet been priced into markets.
Global developed markets investor sentiment
Sentiment among global developed-markets investors (green line) became increasingly bearish last week, ending at its lowest level since February of this year. Global investors have been factoring in a volatile currency outlook in addition to the prospect for global stagflation. Forecasts for global growth and global trade continue to face downward revisions by major international think-tanks including the IMF and the World Bank. Rising risks and declining return forecasts will continue to exert pressure on both markets and investor sentiment. The latter is too negative to support a rally and is likely to lead to further overreactions to negative news when it comes, leading to further downside risk for markets. Corporate earnings have been resilient so far but are not expected to provide a positive surprise this time around and could add to the need to further discount valuations in the short-term. Any positive news, if it comes, will need to be in the form of successive and sustainable monthly declines in inflationary pressures, giving central banks some room to pivot to more stimulative monetary policies. Until then, sentiment is unlikely to recover.
Asia ex-Japan markets investor sentiment
Sentiment among Asia ex-Japan investors (green line) reached a new year-to-date low, ending the week at the most bearish level of all markets we track. In addition to the trifecta of negative macro factors — higher US interest rates, a strong USD and slowing global growth — regional investors are also discounting a further deterioration in the US-China relationship as well as the possibility of new COVID-19 related lockdowns in China as we head into the winter months, further disrupting the already strained global supply chain. As in other markets, investors have been pricing in their base case scenario for the global economy over the next few months, but probably not their worst-case one yet. With sentiment this bearish, any negative news will trigger another wave of selling pressure.
Global emerging markets investor sentiment
Sentiment among global emerging-markets investors (green line) fell last week, in line with other global markets, ending bearish for the first time since early March of this year. The sudden deterioration in sentiment is remarkable in that global emerging-markets investors were mildly bullish only one-and-a-half month ago. Since then, the USD has strengthened, US interest rates have increased, forecasts for global growth and global trade have been revised down, and the energy crisis has worsened. All this has pressured sentiment down from hopeful in late August, to fearful now. Nothing short of a stellar earnings season will raise it back up in the near term.
Japan market investor sentiment
Sentiment among Japanese investors (green line) ended last week bearish after a steady decline for the past two months. The weak Japanese yen has kept up hopes for strong earnings from Japanese exporters and has prevented investors from aggressively pricing in the prospect of a global recession. As a result, the Japanese market has outperformed other developed markets year-to-date. Any signs of declining consumer demand, both at home and overseas, will force investors to start pricing in a stagflation scenario for next year, at precisely the time when year-on-year exchange rate gains will wear off. At this point, the Japanese market seems well ahead of sentiment and the net negative risk appetite should cap any upside potential from here and add to downside momentum in the event of negative news.
China (domestic) investor sentiment2
Sentiment (green line) among Chinese (A-shares) investors was unchanged as the market was closed last week. As such, note that these charts refer to data from the previous week.
2 Note that as of the end of May 2022, we have switched to using a core benchmark as estimation universe instead of the broad market portfolio to better capture the behavior of institutional investor by removing the small caps from our analysis.