Investor sentiment saw a late week rebound in all markets we follow, except in Japan and global ex-US markets where it remained unchanged (China was closed on Friday). Concerns about the slowing global economy were made worse in the last two weeks, by worries about a potential US government lockdown and slowing Chinese manufacturing activity. Both concerns seem to have been avoided over the weekend with a last-minute deal for a continuing resolution in the US, funding the government until mid-November, and better than expected PMI data in China. While the Chinese market will remain closed for most of this week in celebration of the Golden Week festivities, we can expect sentiment to continue to recover across all other markets.
Except for Japan (up) and the UK (flat), August and September were not positive for either sentiment or markets. In the last two months, investors have come to grips with the first signs that the economy is being affected by the unprecedented rise in interest rates of the last 18 months, as well as the reality that central banks are going to keep interest rates higher for longer than previously thought. The only exception is the BoJ which remains M.I.A., and the BoC which is busy putting out credit default fires in its property sector, as well as stimulating its economy back to growth.
Those macro worries were compounded by political concerns in the US (shutdown), stimulus concerns in China (will it work?), and fears of currency intervention in Japan (USD/JPY 149.50!). All three weighing further on sentiment.
Over the weekend, a budget deal was struck in the US, better-than expected PMI data was released in China, and the BoJ remained absent from currency markets. This should help sentiment build on the initial rebound started late last week but keep in mind that you can’t turn a ‘Bear’ into a ‘Bull’ without a ‘Neutral’ in between.
Except in the US and Global Developed markets, the supply and demand for risk is balanced, lowering the probability of an overreaction by investors. In the US, risk aversion levels remain well above those of risk-tolerance, creating the potential for an overreaction to the downside, in the event of unforeseen negative news (see potential triggers section above).
A dysfunctional political environment in the US could potentially add to the triggers on the macro front. This week will see a challenge to the (Republican) Speaker of the house and escalating legal troubles for ‘leaders’ of both parties.
Last week’s Republican debate will only have served to strengthen Donald Trump’s lead in the polls as the party’s presumptive candidate for President of the United States part II (short awkward silence). As for Joe Biden, a recent CNN poll found that “73% of Americans are seriously concerned about his age, physical and mental competence”, and “76% worry about his ability to serve out another full term if reelected”.
Polls continue to suggest the US is headed for a repeat showdown between the abdominal showman and the ageing sandman, the prospect of which will act as a dampener on sentiment from time to time. As for the rest of the world watching it unfold, no one can make sense of it, but everyone has their popcorn at the ready.
Potential triggers for sentiment-driven market moves this week*:
US: Speeches by several Fed officials, manufacturing PMI data, factory orders, and the jobs report.
Europe: Manufacturing and Services PMI data for several European countries, August retail sales and unemployment data for the Eurozone.
APAC: Manufacturing and Services PMI data (out over the weekend), and additional measures to support the property sector in China. Q3 Tankan survey and BoJ minutes in Japan. Interest rate decisions by the RBA in Australia and the RBNZ in New Zealand.
Global: The avoidance of a government shutdown in the US and better PMI numbers for a second month in a row out of China should help sentiment recover for global investors.
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). 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.
Asia ex-Japan:
Australia:
China:
Developed markets:
Developed markets ex-US:
Emerging markets:
Europe:
Japan:
UK:
US:
* If sentiment is bearish/bullish, a negative/positive surprise on these data releases could trigger an overreaction.
Author: Olivier d'Assier, Head of Applied Research APAC, Qontigo
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