Given the myriad financial issues plaguing Europe over the past couple of years, it is no surprise that investors have been particularly reluctant to take on risk. With America now clearly being dragged down by Europe’s problem and China and other parts of Asia also adversely affected, this caution has been justified to some extent. During May, when most investors and traders feared the worst, the MSCI World Free index of global equities dropped by 8.5% and the Aussie dollar fell by almost 7%.
Interestingly, although both equities and risk currencies such as the Aussie have since retraced around 70% of the ground they lost in May, investor trepidation remains extreme. One survey conducted by the American Association of Individual Investors shows that 44% of respondents believe US equities will decline over the second half of this year; this is a very elevated reading, and moreover it has been well above average for the past two months. Not surprisingly, this survey has a very good track record as a contrarian indicator. For example, back in early March 2009, the pessimism reading for this survey was at a historical high of more than 70%.
Should European leaders show more willing as they did last Friday at the EU Summit in Brussels, then investors right around the world might progressively shed their protective instincts. Risk assets and currencies such as the Aussie and the euro would be expected to benefit.