Author: Olivier d'Assier, Qontigo
Potential triggers for sentiment-driven market moves this week1:
US: Earnings reports from Bank of America, Morgan Stanley, Goldman Sachs, IBM, Netflix, Tesla, Johnson & Johnson, Philip Morris International and American Express. On the macro side, investors will get retail sales, industrial production and housing data.
Europe: UK inflation and retail sales.
APAC: China Q2 GDP growth rate, retail sales, industrial production and fixed asset investments; Japan inflation; Australia retail sales.
Global: Q2 earnings reports, forward guidance and the strength (or lack thereof) of the world’s second-largest economy.
Insights from last week’s changes in investor sentiment:
Investor sentiment continued to decline last week across all markets we follow, ending at fresh 2023 lows in Australia, China, Developed ex-US Markets and Europe (with Developed Markets narrowly escaping that fate — for now). Sentiment in five of the ten markets we cover turned bearish last week, with sentiment in China on the brink of joining them. Sentiment among US investors went from bullish the previous week to neutral last week, thanks to a better-than-expected inflation report for June, and stronger-than-feared Q2 earnings (with only 6% of companies reporting). This has prevented investors from turning negative just yet. Elsewhere, the market rallies seen globally except Japan seem out of sync with a weakening sentiment and may not be sustainable.
Throughout history, what has driven investors to act as a group can be divided into two general categories: common need and common want. The former involves investment compliance, the latter has to do with exposures to pockets of alpha. The two categories are somewhat interchangeable because the needs and wants of a strategy are, like tie dye, inclined to bleed. The question of which category is the strongest often comes up. Need is, of course, not wholly without virtue. Want alone is sometimes insufficient, and it becomes necessary that decisions possess a certain measure of need in order that they might be distinguished one from the other. Investors want to believe in the pivot theory, but central banks continue to push the need for a discussion of higher interest rates in a manner slightly beyond acceptance and more in the realms of “Trust us, this will be good for you.”
During the first half of the year, markets gradually shook off their fears of a worst-case scenario for the economy, and with a lot of risk-averse investors having already jumped ship to fixed interest assets in 2022, the more risk-tolerant dominated market continually played the economic resilience game rather than the fear of a hard-landing one. Six months into 2023 and all we can say is that we are (probably) closer to finding out the economy’s fate. Central banks are also less sanguine about inflation, now that it has peaked and is on a downward slope towards their target rate, than they were at the start of the year. And there are a lot of risk-averse investors waiting on the sidelines for a clear sign that it is safe to jump back into equities. For now, without further clarity on the above, the base-case scenario for the second half of 2023 is a mirror of the first half’s performance, simply because markets hate giving even the appearance that they are being blatantly anti-symmetric.
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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