EXPERTISE - NN Investment Partners

Despacito

09 Octobre 2017 Par Valentijn van Nieuwenhuijzen
 (Photo: NN Investment Partners)

Yet another week full of political turmoil. The drive for independence in Catalonia, hurricane damage in Puerto Rico and raging Brexit debates in the UK all continue to create massive challenges for the governments in charge. In none of these cases it seems that political leadership has been very effective in resolving the tension (to put it mildly). Let’s hope that changes quickly, but let’s also realize that it might not be that important to markets how quickly these matters are calmed down. Markets have learned in recent years to look through the political fog.

As long as the global economy continues to look solid, labour markets heal further and corporate profits continue to grow healthily, it remains unlikely that markets will falter. This awareness should help for investors to keep their calm and take it easy in responding to political noise. 

Whether markets will actually continue to move higher is another matter. For that, things do not only have to stay good, but need to get better. This is why it is so important to always look at the direction of change for investors; to monitor carefully if the underlying economic fundamentals are accelerating or rolling over. To identify where investor appetite and flows are shifting towards and where fear is building or investor holdings are stretched.

The way investors are feeling and behaving has been a bit more mixed recently. Obviously the political headlines have not gone unnoticed and furthermore worries over high valuations keep many of them on alert for potential shake-outs in the market. Above average cash holdings on money managers is one way where this is expressed, while the relatively volatile exposure towards risky assets (like equities) is another phenomenon that reflects the investor nervousness. Against the background of very low volatility in the market itself, it stands out how large the swings have been of active fund managers in their implicit equity exposure.

At the extremes this type of positioning indicators offers some contrarian insight on where the market might trade over the next couple of weeks. By the middle of September the exposure towards equity markets was actually pretty high again (with stronger data pushing back political fears) and was sending some contrarian signs of short-term caution on equity markets. In recent weeks however position has become less extreme and therefore no clear signal is seen at this stage. The underlying message from sentiment indicators is a bit similar. Surveys that map investor bullishness on the market show that the balance between Bulls (positive) and Bears (negative) reached one of the highest levels of the last 3-years by mid-September, but also that we are almost back to a neutral stance by now.

 

Meanwhile, metrics that capture investor sentiment on the global growth outlook improved a lot for most of last year and the first half of this year, but have started to roll over from the second quarter onwards. These are not so much contrarian indicators, but more information that helps to assess the direction of change in investor flows. Therefore, the modest down-drift in growth expectations until September was a bit of a behavioural negative for risky assets until recently. Given its recent (modest) bounce it now looks more neutral as well.  

Yet another way to help us in profiling the overall mood and near-term behaviour of investors is to use digital newsflow from professional news platforms and social media sources. By measuring expressions of uncertainty, volatility and market risk and translating that into our NNIP Uncertainty index we can add another bit of colour to the emotional expression on the face of Mr. Market. The sentiment related to overall uncertainty deteriorated noteworthy in August and September (see graph below), probably also related to political and/or monetary policy (Fed, BoE) uncertainties. While sentiment remains at low levels (stemming from high uncertainty!), it has recently also been rebounding and thereby stopped sending clear negative short-term signals.   

 

 

One element that actually sends much more positive signals for risky assets is ongoing herding behaviour, or momentum, in markets. One of the oldest, most documented and most reliable behavioural signals in financial markets and one that currently sends firm votes of confidence on equity and credit markets. On the latter the support has been visible for most of the third quarter, but for equities it has re-emerged more in recent weeks. Interestingly enough, however, this is not (yet?) coinciding with a strong pick up in flows in most risky assets.

Combining all the behavioural trends does not give a very clear picture therefore, but it does suggest that the negative undertone that was visible for most of September has started to fade. That on its own is already important, because the fundamental picture continues to offer support and has even brightened a bit further in recent weeks. Taking a calm look at the way that reliable returns drivers are evolving, rather than focusing on news headlines, triggered us to add a notch to our risk-on stance.

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