Following months of increased risk exposure among institutional investors, the latest State Street Risk Appetite Index recorded a sharp rise in July.
Having remained flat at 0.36 in May and June, the index rose to a staggering 0.54 by the end of July – a level not seen since November 2020, the month when COVID-19 vaccines were discovered.
Despite numerous potential pitfalls for financial markets this quarter, head of macro strategy at State Street, Michael Metcalfe, said institutional investors remain highly optimistic.
“Their aggressive buying of risky assets mirrors the fervor seen in November 2020, when COVID vaccines were announced. This suggests that investors believe the peak of uncertainty, whether geopolitical or policy-related, has passed,” he said.
However, he noted the sharp divergence between their confidence and the persistent decline in business confidence, particularly in the US, as a cause for concern.
This past month, long-term investors increased their equity allocations by 0.7 per cent, reaching 54.8 per cent – close to the highest levels seen in 25 years. Alarmingly, the only times they were higher were during the dot-com bubble and the GFC.
As Metcalfe explained, this context might see investors proceed with caution, since today’s buoyant sentiment “could be vulnerable to shocks”.
Zooming in, he observed “intriguing nuances” beneath the surface trend of optimism.
Regarding the US market, investors continue to show a preference for US consumer discretionary stocks. According to Metcalfe, this trend could indicate potential disruptions to their growth outlook.
He also highlighted the recent stabilisation of sentiment surrounding the US dollar following a five-month period of consistent investor hedging against the currency.
He said this also suggests that investors believe policy uncertainties may have reached their peak for the time being.
Meanwhile, Metcalfe noted a rebalancing towards global growth, with strong cross-border flows seen in Japan, China and Brazil.
As senior client portfolio manager at American Century Investments, Bernard Chua, explained, after years of underperformance amid a deflationary economy, Japanese equities in particular are gaining popularity among domestic and foreign investors.
“With the previously dominant ‘Magnificent 7’ and broader US exceptionalism lagging this year, investors are increasingly looking beyond traditional outperformers for growth potential, and after decades of underperformance relative to global peers, Japan is experiencing a meaningful inflection point,” he said.
On the other hand, Metcalfe attributed the relatively weak demand for Indian equities to ongoing tariff and policy uncertainties.
This follows US President Donald Trump’s surprise announcement last week of an additional 25 per cent tariff on Indian goods, bringing the total duty on Indian exports to 50 per cent.
Finally, fiscal concerns also continue to cast a shadow, particularly evident in the continually weak foreign demand for sovereign debt instruments such as US treasuries, UK gilts, and French OATs.
Metcalfe said the lukewarm interest in government bonds from major economies suggests lingering concerns about debt levels, inflation, or the future direction of monetary policy still persist.
