Blog Posts — April 9, 2021

Leveraging Sentiment to Boost Performance in a Rotation Scenario

The first quarter of 2021 provides an excellent opportunity to see how investor sentiment—as measured by the Sector ROOF[1] ratio—can be leveraged in a market under a rotation scenario. Ever since news of multiple COVID-19 vaccines hit the streets, economic-recovery forecasts have created a rotation trade out of pandemic winners and into pandemic losers. Value outperformed growth, small-caps outperformed large-caps, Momentum was thrown into reverse, and economically sensitive sectors outperformed defensive ones.

The chart below shows the cumulative return for the STOXX USA 500 index (black line) and the Sector ROOF ratio for the US market from Q4 2020 through the end of Q1 2021. The highlighted period on the left, labelled “A”, shows the sharp positive impact of the vaccine news on investor sentiment between November 11 and December 21, as the Sector ROOF ratio rose from bearish (below -0.5 on the left axis) through both the US presidential election and as the delay in passing a second COVID-19 stimulus package weighed on sentiment in early November 2020, to strongly bullish (above +0.5 on the left axis) by late December, following the Democratic win and the expectations of a bigger-than estimated stimulus package under the Biden administration. The second highlighted period labelled “B” on the right shows the impact on investor sentiment of both the second wave of new infections and the threat of renewed lockdowns since December 21, 2020. The Sector ROOF ratio declined steadily during that period, ending Q1 2021 back in bearish territory.

The positive impact on sentiment from the vaccine news and upward revisions in economic forecasts then gave way to concerns about a delayed recovery, inflationary pressures from over-stimulus, and worries that increased volatility from retail investors would burst the current valuation bubble.

So, was being sentiment-aligned during those two distinct periods rewarded by the market?

The chart below shows the performance of our Risk-On (blue line) and Risk-Off (green line) portfolios[2] during period A, from November 10 to December 21, 2020. During that period of rapidly improving sentiment, the Risk-On portfolio outperformed both its Risk-Off peer (green line) and the parent index (black line), the STOXX USA 500, with a cumulative return of 8.8% versus 3.0% and 5.7% respectively.

In sharp contrast, the chart below shows the performance of our two sentiment-aware portfolios during period B (December 22, 2020 to March 31, 2021), which saw a deterioration in sentiment from December 22 until the end of Q1 2021. During that period, the Sector ROOF ratio declined from above 1.0 to below -0.8, with only a brief hesitation in the middle. During that period of almost continuous deteriorating sentiment, the Risk-Off portfolio (green line) outperformed both its Risk-On peer and the parent index with a cumulative return of 8.8%, versus just 0.2% and 6.5%, respectively.

We note that during period B in the chart above, the return of the STOXX USA 500 parent index was itself strongly positive, which could be interpreted as a ‘bullish’ period, but investor sentiment as measured by the Sector ROOF ratio was simultaneously becoming increasingly negative (i.e., things are not always as they seem). By way of a caveat, sentiment indicators like the ROOF ratio are not buy or sell signals. If anything, they are about not knowing what’s coming next, but simply quantifying how investors are likely to react to it, given their confirmation bias at the time. Put another way, Roof ratios are about the sentimental narrative that sometimes overpowers actual events and elbows conventional responses out of the picture while no one is looking.

By now it should be clear that the market/sentiment relationship is a kind of unequal partnership akin to the host/parasite one. At times, the host will ignore the parasite, but often at its own peril. Investors exert a great deal of energy trying to get their realized returns to match their expected ones, even if the latter seems increasingly contrarian. Being sentiment-aligned, however, can famously keep realized gains from becoming realized losses. During period B above, adopting a risk-on strategy by reacting to the bullish returns of the parent index (the host), while ignoring growing bearish sentiment (the parasite), would have turned positive active returns into negative ones. Instead, remaining fully invested, but adopting a more defensive risk-off strategy aligned with the degrading sentiment, delivered even greater rewards than passively following the market’s lead—a case of the student (of sentiment) becoming the master.

Finally, this being a quarterly review of our ROOF Portfolios, we present below the performance chart for Q1 2021 in full, for both the Risk-On and Risk-Off US portfolios against their parent index, the STOXX USA 500. As noted above, Q1 2021 was a quarter in which the market and sentiment diverged. Both were briefly aligned in February, becoming increasingly divergent again in March. Over the quarter, the best strategy was one that followed the market (i.e., kept a market Beta of 1.0) but listened to investor sentiment by being fully invested in a portfolio that over-weighted risk-averse sectors and under-weighted risk-tolerant ones[3].

For the quarter, the Risk-Off portfolio delivered a cumulative return of almost 7%, compared with a return of just over 5% for the STOXX USA 500 parent index, and a negligible loss of -0.3% for the Risk-On portfolio. This past quarter represents a perfect example of the value added by sentiment indicators, even in up markets. Investors using sentiment indicators as overlays to their own signals can maximize the active returns they extract from their research by keeping the sentiments of other investors in mind when constructing their portfolios.

Finally, the tables below detail the active sector allocations across each of the 11 GICS sectors for both of our ROOF portfolios. These portfolios are rebalanced monthly, at month-end, and their allocation is based solely on the then-current ROOF personality of each sector from its exposures to the eight style factors in the ROOF methodology.

We see that the Risk-Off portfolio was heavily under-weight the Consumer Discretionary (CD) and Information Technology (IT) sectors—home to many of the pandemic profiteers that were so popular during the pre-rotation trade period. It was also heavily over-weight the Financial (FI) and Consumer Staples (CS) sectors. During the quarter, it progressively increased its over-weight in the Communication Services (TS) sector, and its under-weight in the Health Care (HC) sector. And although the active weight in Energy was small, the sector’s return was quite positive and also contributed to the outperformance.


The direction of markets often masks dangerous motivational undercurrents. In the first quarter of 2021, market returns and investor sentiment sharply diverged, with the former rising as the latter fell continuously to end the quarter at 12-month lows not seen since the height of the pandemic a year ago. By leveraging insights from the ROOF Scores on the changing nature of investor sentiment, and realigning the portfolio away from risk-tolerant sectors and towards risk-averse ones as risk appetites soured, a sentiment-aware investor could have turned a strongly negative active performance for Q1 2021 into a strongly positive one, while remaining fully invested.

[1] The acronym ROOF is Qontigo’s sentiment indicator and stands for Risk-On / Risk-OFf

[2] The Risk-On and Risk-Off portfolios are constructed using the Sector ROOF Scores. Details on the methodology can be found here.

[3] The Risk-Tolerant and Risk-Averse personalities of each sector are defined by sector exposures to the eight style factors used in the ROOF methodology and are computed daily.