Geopolitics is back in the headlines — and back in the driver’s seat for markets.
The latest flare-up in tensions in the war with Iran has weighed on risky assets over the past week. But the shock value is far lower than it was a few months ago.
That is normal.
Geopolitical shocks often create short-term market dislocations, but those moves rarely persist unless the situation escalates into a meaningful hit to global growth or corporate profits.
There is also less uncertainty the second time a risk flares up. Yesterday’s “new crisis” becomes today’s “well-understood scenario”.
Investors now have a much better understanding of the potential economic implications, the likely impact on individual companies, the supply-chain risks and the exposures within their funds. Every transmission mechanism has already been dissected.
In practice, it therefore usually takes a sharper escalation to trigger the same market reaction — and to push sentiment into genuinely worrying territory.
As before, my favourite way to track this story from a sentiment perspective is the Geopolitical Risk Index, or GPR. It captures spikes in perceived geopolitical stress — in other words, the geopolitical risk premium.
Historically, when the GPR has risen above 300, the S&P 500 has delivered above-average returns over the following month 81% of the time. Monday's data update will show whether we have reached that threshold.
Another sign that this episode is very different from the last one is the market behaviour beneath the surface.
In March and April, investors rotated out of almost all cyclical exposure, initially into defensives and ultimately into secular growth areas such as Technology.
Over the past week, several of March’s biggest losers have instead been among the outperformers: European equities, Industrials, Value and Brazil.
Overall, the market setback has taken sentiment back to neutral.
Both the high-frequency and all-in versions of our Risk-On/Risk-Off aggregates have declined. In situations like these, however, I would put greater weight on the high-frequency indicator.
It has fallen to the 52nd percentile. That is well above the March lows, but also well below the year-to-date and July highs.
Top 3 This Week
1. Sentiment: Neutral
Geopolitics has pushed investor sentiment back down to neutral.
2. Technology still bullish
Despite weaker performance, sentiment indicators remain close to bullish extremes. There is no sign in our data that bullishness towards Technology has washed out.
3. Brazil reversal
We flagged extreme bearishness in Brazilian equities in early June. The picture has since flipped. Alongside better performance, sentiment is becoming increasingly bullish — though it is not quite extreme yet.
Sentiment Overview
The decline in risky assets has left its mark on the weekly surveys.
- AAII Bull-Bear dropped to its second-lowest level since March, with a reading of -13% net bearish. That may not sound especially bearish, but the indicator has only been lower 14% of the time.
- NAAIM Exposure also declined, although not by as much as AAII, and remains at the 72nd percentile.
- Investors Intelligence Bull-Bear has not moved yet. By historical standards, it remains the most bullish of the three surveys, at the 89th percentile.
Once again, the wide range of messages from these surveys highlights the importance of looking at the breadth of the data rather than simply picking one favourite indicator.
Sentix IPO sentiment has fallen to its lowest level since last year’s Liberation Day sell-off and is now back at its long-term average.
The optimism seen ahead of the SpaceX IPO has all but disappeared. That does not bode well for the pipeline of high-profile IPOs, although month-to-month data can be volatile and it is too early to call this a new trend.
The latest ZEW analyst expectations confirm several messages we are seeing elsewhere:
- Broad equity sentiment remains neutral.