Potential triggers this week: US GDP growth for Q3, personal income and durable goods orders (yawn). The earnings season continues, with Alphabet, Apple, Amazon, and Facebook due to report their Q3 results. Elsewhere, the ECB and the BoJ will announce their monetary policy decisions (big yawn). And of course, the US presidential election is only ten short days away.
Summary: Sentiment continued to weaken across all markets we track, except the UK (denial ?!). Elsewhere, the Sector ROOF for the US market broke below the neutral zone into bearish territory (<-0.5) for the first time since April. Japan, Australia, and China are the most positive markets, with ROOF Ratios there still in bullish territory (<+0.5). Four of the FAANGs are scheduled to report Q3 earnings this week, and with the US presidential election the following week, investors are likely to tread carefully over the next few days. As risk aversion levels rise, investors’ cognitive bias becomes more sensitive to negative news than positive one, making them prone to over-reaction to unexpected risk events and increasing downside risk for markets. Triggers could include big earnings miss by one of the FAANGs, a deteriorating Covid-19 narrative around further social distancing restrictions, or an increased likelihood of a disputed election result in the US next week.
Risk aversion rises further and pushes overall sentiment below the neutral zone.
Sentiment in the US nose-dived last week with the Sector ROOF ratio falling below the neutral zone into bearish territory for the first time since early April (top chart). The gap between our Sector and Style ROOF variant these past weeks indicates that investors failed to gain enough confidence about the strength of the economic recovery to start a rotational trade into other sectors. Negative earnings surprise from any of the FAANGs this week could trigger an over-reaction. Risk aversion (red line) surged, and risk tolerance (green line) declined further last week creating a demand and supply imbalance in favor of supply (bottom chart). In these conditions, negative news can trigger a rush for the exits by the more numerous risk-averse investors who will then be required to offer large price discounts to the fewer risk-tolerant investors left willing to increase their holdings of risk assets (i.e. why markets fall). Of course, it is possible that no negative news comes out to trigger this negative cognitive bias – earnings are as expected, no further safe-distancing measures need to be taken, and the election goes smoothly/peacefully. In which case nothing happens, and the imbalance remains ‘un-triggered’, but remains nevertheless until good news comes to reverse it. But, if bad news does come, then watch out.
Despite rising new infections and restrictive measures, sentiment in Europe improves.
European investor sentiment rebounded last week according to both our ROOF variants (top chart). Markets, however, did not capitalize on this slightly more positive cognitive bias ending the week below the previous one. Both ROOF variants remain in the Neutral zone, meaning that cognitive bias is neither strongly positive nor negative, and investors lack the conviction needed to change their risk appetite. They remain hopeful another set of stimulus measures will come, but half fearful they will not be enough if further social distancing measures need to be imposed ahead of winter.
Risk tolerance (green line) and risk aversion (red line) traded places this past week in Europe but remain balanced. In this equilibrium state, risk appetite remains flat with neither the supply nor demand for risk being able to extract a price discount or premium from investors (i.e. why markets trade sideways). The ECB’s monetary policy decision later this week (Thursday) is not expected to provide much guidance either. And so, it seems that European investors are heading into winter without much direction and are evenly divided as to whether conditions will improve or not. Keep in mind that in this age of stimulus economies, neutral is the new bearish, so don’t rule out a move to the downside if negative stimulus news comes out.
Sentiment deteriorates further for both Global and Asia ex-Japan investors.
Global investors’ sentiment continued to weaken this past week with both variants of our ROOF ratio falling deeper into neutral territory (top chart). The sector variant has been more negative than the style variant for some time now, indicating that positive sentiment is only felt for a handful of sectors and that investors do not feel the current economic recovery is broad enough to rotate into other sectors. Risk appetite remains balanced with only a slight negative bias but has now dipped below where it has been all summer and is back down to April levels.
Sentiment in Asia ex-Japan mirrored its peers and declined further into neutral territory last week (bottom chart). Risk aversion in our Sector ROOF variant has now risen above risk tolerance levels for the first time since April, but the two remain evenly matched in our Style ROOF variant. The Covid-19 narrative is a good one in developed Asia, except in Australia right now, but the region remains economically dependent on global trade and GDP growth. So, while it looks favorably on signs that the Chinese economy is recovering well, investors in the region remain weary of the post US election relationship between the US and China and the possibility of renewed trade tensions, no matter who wins the US election. Here too, neutral is the new bearish.