EXPERTISES - INVESTMENT VIEW

The confused investor

07 Mai 2018 Par Valentijn van Nieuwenhuijzen
 (Photo: NN Investment Partners)

So far 2018 has taken a completely different shape than last year, which was full of positive surprises on data, earnings, politics and US fiscal policy. Now, things have changed and investors need time to adapt to this new, less supportive and more uncertain environment and are less willing to take large directional bets.

The turning point was the sudden sell-off in early February. Although this correction was mostly described as technical, nervousness has increased, which is reflected in higher volatility and markets moving largely sideways. Year to date, global equities (in euros) are up a breathtaking 0.07%! The risk-return trade-off has certainly deteriorated.

What certainly is not helping to restore investor confidence are the confusing signals being sent by data and politics. An example is US corporate earnings, which are well above expectations both on a revenue and on an earnings basis but fail to fuel a sustained rally in equities. Instead, anxious investors are looking for signs that earnings growth has reached a cyclical top. This leads to asymmetric, risk-averse price reactions. Companies hinting at cost pressures are punished even after publishing very strong results, while companies delivering strong results accompanied by a positive outlook are not rewarded to the same extent. This market reaction is a typical late-cycle phenomenon. It may be premature.

Another example is in the reading of macro data. From an absolute level, these are indicating continued growth even if the acceleration phase is behind us. However, relative to expectations and outside the US, macro data disappointed. Similarly, our global cycle indicator, which captures a wide set of forward-looking indicators, remains in negative territory both on a 1-month and on a 3-month view. At the same time, though, in his dovish post-meeting press conference, ECB President Mario Draghi tried to attribute the data softness to special factors and confirmed his confidence in the inflation outlook.

Did he really have any other option? Probably not. The ECB needs to signal continued confidence in the strength of the expansion.

We fear that these “half-full, half-empty glass” messages will continue to weigh on investors’ risk appetite. For us this means that measuring investor sentiment regarding these fundamental variables is important.

Confusing messages are also reaching investors from the political side. The Trump administration delivered tough messages on protectionism earlier in the year. Since then, we have witnessed a softening of the stance, the latest being an extension of the relief from the steel tariffs for Europe, Canada and Mexico until 1 June. Trump’s bark is apparently worse than his bite, thus far, but it keeps this US administration hard to read. The observation that news flow on trade was responsible for most of the largest daily market moves in March, both in a positive and in a negative sense, proves that capturing political sentiment is important.

On the Korean Peninsula things are moving surprisingly fast. Six months ago, when tensions reached new highs and mutual insults were common, who would have imagined an intention to close nuclear test sites in North Korea and a potential meeting with Trump? In the Middle East, though, there is no progress. On the contrary, it remains a factor that continues to drive oil prices higher and may start to add pressure on emerging markets.

So, in an environment characterised by uncertainty from the data and political sides, we observe some tentative signs of a bottom in investor sentiment on both variables. It is once again a good illustration that an analysis of behavioural factors, including investor positioning, price momentum and flow momentum alongside sentiment data, is an important input in our investment process. It helps us to benefit from the behavioural biases of other investors.

From this point of view, the improvement in sentiment combined with better fundamental data (stabilisation in earnings momentum and economic surprises) could create a better environment for risky assets; at least it may help to look through the confusion of investors.

 

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