Chart Of The Week: EM Equity Sentiment Tumbles (Contrarian Bulls Take Note)

Emerging market equities have taken a solid beating this year, down more than 20% from the top (depending on which index you look at). With this poor performance has come a change in heart by investors who have gone from extreme optimism to now increasingly pessimistic.

The chart comes from a special report on Asian FX, emerging market (EM) currencies, and the EM macro and equities outlook.

The chart shows our proprietary composite sentiment indicator for emerging market equities, and the picture emerging is very clear.

emerging markets equity sentiment indicator

The sentiment indicator incorporates just about every data series we have relating to sentiment on emerging market risk assets, for example: fund flows, risk pricing across equities/credit/sovereign, economic sentiment, and earnings revisions, to name some of the key factors. Basically it is intended to bring a consistent and purer signal by incorporating a wide source of data.

The way we think about sentiment is firstly to quantify it and, importantly, to bring it in as a contrarian signal. That is, pay increasing attention on the bearish side when sentiment is extremely optimistic (and particularly when valuations are higher, technicals are overbought, policy is tightening, and economic indicators are starting to falter). Likewise, when you see the indicator behaving like it is now, it adds to the contrarian bullish case.