Author: Olivier d'Assier, Qontigo
Potential triggers for sentiment-driven market moves this week1:
US: FOMC minutes, manufacturing and services PMI, factory orders, foreign trade data, June jobs report.
Europe: Eurozone producer prices and retail sales; Germany’s industrial production, factory orders.
APAC: China services and manufacturing PMI data; Japan’s Tankan Manufacturers Index; interest rate decision in Australia.
Global: Central banks in the US, Europe and Australia continue to forecast higher interest rates in the near term, pushing back the pivot theory to 2024 at the earliest.
Insights from last week’s changes in investor sentiment:
Investor sentiment continued to ease last week, settling into the neutral zone ahead of the Q2 2023 earnings reporting season. The only exception was in the US, where investors ended the week bullish, encouraged by the sustained decline in inflation and a resilient economy. Sentiment among global emerging-markets investors continued to decline, ending the week bearish for the first time since April. Meanwhile, investors in China pared down their pessimism about the weakness of the country’s economy, ending the week neutral ahead of expected stimulus measures by the authorities. Overall, the US market continues to present the best case for an extension to the recent rally. The case for Europe is neutral, the one for Japan is weakening, and the one for China will hinge on the largesse of stimulus measures.
In the US, most of the rally in equities during the first half of the year has been led by big technology stocks, themselves driven by the hype around AI, whose only gift so far has been how far it can stretch valuations to scratch an earnings itch companies cannot reach. Volume in tech stocks has surged as investors bought the whole “But wait… there’s more! If you buy now …” thing, turning the stock market into a version of Narnia where every company logo is a secret door to an AI utopia (think Skynet and bring it down many, many notches). But, for now, volatility says there is still time to place your wager before the start of the earnings season. So bet now or forever hold your chips.
In Europe, the rally in the Consumer Discretionary sector (namely, luxury goods in particular) has run its course and sentiment has gone from positive to negative in the last two weeks as the ECB made it clear it would not be pivoting this year either. Investors there remain focused on large-cap, low-P/E stocks and are ignoring growth and momentum. In Japan, the rise in volatility since March combined with a 20%+ rally is raising some red flags with investors who are huddling together on a narrow strip of large-cap., low-PE, Value stocks as they seek downside risk protection from rising volatility. China has seen the positive economic momentum from its reopening dwindle, driving down sentiment from positive to negative, but recent talks of additional, and, one hopes, bigger stimulus to come has brought sentiment back up to neutral as investors give regulators the benefit of the doubt for now.
Risk-averse investors point to the fact that the rally in equities has been very narrow, concentrated in just two sectors and one theme. Inflation is still higher than target, interest rates are expected to keep rising, and inverted yield curves continue to predict an eventual recession. Risk-tolerant investors point to the fact that volatility is low, the economy is resilient, inflation has peaked, volatility is low, the jobs market and consumer spending remain strong, all the world’s problems will be resolved by AI, and, did we mention it, volatility is low. For now, investors sitting at the Long Bar are starting to see the glass as half full, until, that is, they remember they ordered a double.
Note: green background = bullish, red background = bearish
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). In between those two lines, 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.
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.
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