Author: Olivier d'Assier, Qontigo
Potential triggers for sentiment-driven market moves this week1:
US: June inflation report, followed by speeches from several Fed officials. Q2 earning results from Citigroup, JPMorgan Chase, Wells Fargo, Delta Air Lines, PepsiCo, BlackRock and UnitedHealth Group.
Europe: final inflation readings for Germany, Spain and France; ZEW Economic Sentiment indicator for Germany; Eurozone industrial production and trade balance.
APAC: China trade balance, housing prices and June inflation report.
Global: Update from corporates on the impact on profit margins from the prolonged restrictive monetary policy, and ongoing developments in the war in Ukraine.
Insights from last week’s changes in investor sentiment:
Investor sentiment fell another notch last week in all markets we follow, taking stock prices down with it — perhaps we are seeing a new adage in the making: “Sell in July and don’t ask why”? Following the banking sector’s near-death experience in March, sentiment rose in April and May only to reverse course in June. As of last week, all markets except Japan and the US have completed their turnaround in sentiment. Japan saw its reversal aborted by a late June rebound, keeping sentiment on an uptrend for now, but falling short of recovering the May 26 high, and ending last week neutral. In the US, a combination of low earnings expectations2, a predictable central bank, and a defiant economy have helped sentiment remain bullish.
The global economy appears disjointed: The US economy is defiant, Europe is resilient, Japan is persistent, and Asia ex-Japan is vulnerable. Currently, the US economy continues to make the best case for investors who enter the Q2 earnings reporting season this week with bullish expectations. Geopolitics, meanwhile, isn’t helping. Back-to-back visits by high-ranking US officials to China in the past month have left global investors with nothing but the usual “He said, Xi said”3 status quo on the US-China relationship. While the lines of communication may be open, no one from the military is calling, and investors aren’t buying the rapprochement bonus. The ongoing realignment of the global (technology) supply chain outside of China (a strategy advocated by Janet Yellen!) will continue to benefit peripheral countries (India and Japan mostly).
In the US, concerns about the economy will take a backseat as company CEOs take to the stage for the Q2 2023 reporting season over the next few weeks. Forward guidance will once again be key for sentiment and CEOs would do well to remember that in the stock market (like in politics) it’s not whether you win or lose — it’s how you lay the blame. As for investors, some hold the belief that multiple factors are responsible for the price movement of stocks, others believe in the random walk theory where the responsibility lies with a single factor called ‘luck’ that gets around a lot. Both types of investors should keep in mind that talk is cheap, a kiss is just a kiss, but valuations don’t raise themselves.
Geopolitics and the economy are a bold lot — reckless and driven by a deeply felt desire to see how they can impact an investment thesis, and since early 2022 they have been true champions of equal airtime on the minds of investors. But most of them are reasonable. They can accept reality. They can face the facts. What they cannot face, apparently, is the music that comes with missing a rally. To those who feel that while FAITH can move mountains, it takes FOMO to move markets, keep in mind that this is why the market created future rallies.
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.
2From FactSet’s Earnings Insight Blog: “For Q2 2023, the estimated earnings decline for the S&P 500 is -7.2%. If -7.2% is the actual decline for the quarter, it will mark the largest earnings decline reported by the index since Q2 2020 (-31.6%).”
3Referring to Vice Premier He Lifeng’s meeting with US Treasury Secretary Janet Yellen and President Xi’s meeting with Secretary of State Antony Blinken – sorry, couldn’t resist.
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