by Olivier d'Assier
Potential triggers for sentiment-driven market moves this week1:
- US: Fed interest rate decision (exp. unchanged), and PMI data for September.
- Europe: UK inflation and retail sales data for August and the BoE interest rate decision (exp. +25bps). Inflation and PMI data to France, Germany, and the Eurozone.
- APAC: In China, PBoC interest rate decision (loan prime rate). In Japan, BoJ interest rate decision, PMI and trade balance data.
- Global: Any (unlikely) surprises in the Fed’s, the BoE’s, the BoJ’s, or the PBoC’s interest rate decision this week.
Insights from last week’s changes in investor sentiment:
Investor sentiment rose moderately across all markets we follow except the US, the UK, and (by extension) global developed markets, where sentiment continued to weaken but has stopped short of turning full-on bearish, ahead of key interest rate decisions by the Fed and the BoE this week. As of last Friday, the average ROOF ratio for all ten markets we follow was exactly ‘0’, meaning that the average global investor will continue to remain noncommittal, until they’ve been given the safe word. Sentiment in the US, UK, and developed Europe ended the week sour. Sentiment in global developed markets ex-US and Japan ended neutral. And sentiment in Asia ex-Japan, China, and global emerging markets ended on a positive note. So, a “Nah”, a “Meh”, and a “Yeah”, (but no “Yikes!” or “Yippee!”).
The two main components of sentiment are forecasting and volatility. Forecasting is a lot like real estate, it’s all about location, location, location. Where are we in the economic cycle? Where are we in the interest rate cycle? And where are we in the earnings cycle? Get location right and watch reality carry your portfolio to the promise land. Without the right location nothing is possible and everything is pointless.
Volatility is the price of investing, and like with every valuation metric, too low is not valuable enough and too high is too expensive. How much is too low? Not enough to be worth it. How much is too high? More than you can afford. In short, valuation is complicated. It varies according to timing, expectations, circumstances, and how confident investors are in their choice of location.
When confidence levels drop so low, they turn well-meaning forecasts into accidental guesses, that’s when the price of investing can quickly turn into the cost of investing. Costs rise when investors are suddenly forced to deal with a very different reality to the one they expected. Volatility shoots up, turning a cheap punt on a poor location into a rapidly degrading subprime mortgage (remind you of anything?).
Here’s the rub. Volatility, a.k.a., the price of investing, has been declining all year and has reached levels well below the long-term median in every market we track, so ‘price’ isn’t what is keeping investor sentiment in check. Instead, ‘location’ and the inability to confidently forecast where the next subway line is going to be built, is what is holding sentiment back. This is what is preventing a return of investors – average daily traded volume and participation rates remain well below year-ago levels.
An uncertain macro and geopolitical situation have turned investors’ forecasts into a Rorschach inkblot, with multiple interpretations. With investors still unable to confidently pinpoint the precise location of either the economic or interest rate cycle, it will be up to CEOs to clarify the location of the earnings cycle during the upcoming Q3, 2023 earnings reporting season. Following three consecutive quarters of negative growth, the question now is, are we at the beginning of the end, or at the end of the beginning?
Pending clarity on earnings, location forecasts are likely to be classified as “off the record” which on Wall Street means not just “don’t quote me on this” but “you didn’t hear it from me, and I never said this”. Look for sentiment to remain in this state of plausible deniability until next month.
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.
