Potential triggers this week: Second-quarter earnings season gets underway this week (Tuesday), with Johnson & Johnson, JPMorgan Chase, Citigroup, and Wells Fargo. EU leaders to discuss a common recovery plan, while central banks in the Euro Area and Japan will be deciding on interest rates. On the economic data front, US retail sales and industrial production; UK jobs report, monthly GDP, and inflation, Eurozone industrial output, and China Q2 GDP figures.
Summary: Despite a worsening Covid-19 narrative and expectations for a dismal Q2 earnings season (the worst since Q4 2008), risk appetite, building on the rebound from the previous week, ended higher in all markets we track except China. Like modern-day Moses looking for the promised land, investors continue to chase markets higher believing there is a utopian normal only to be found on the other side of a stimulus package. They have invested so much in the hope for a V-shape recovery that they feel compelled to stay the course until the data confirms it – even if there is a growing chance it never will. Unlike in previous crisis when Central Banks intervened only to provide a floor for markets and sentiment, this time around, they seem to be providing a staircase.
Last week’s increasingly risk-tolerant mood turns into full-blown bullish sentiment in the US.
US investors have regained an optimism level not seen since May and January (top chart) with the Style-ROOF (blue line) within reach of a YTD high (pun intended). The Sector-ROOF (green line) which had been headed for the relative safety of the neutral zone, bounced off its recent “low” on Friday. It remains to be seen if both will continue their ascent as the earnings season begins. Q2 results have been written off but the focus will be on the rest-of-the-year guidance. Best advice for CEOs, thrown everything with the trash and paint a positive picture for the rest of the year, if you can.
Risk Tolerance (green line in bottom chart) continues to rise in the Style-ROOF variant (it is flattish in the Sector-ROOF ones), despite forecasts for the worst earnings season since Q4 2008. Earnings growth is forecasted to have plunged 44.6% in Q2 2020 after a paltry 1% growth in Q1. With cognitive bias this strongly positive, mildly negative guidance from CEOs is likely to be ignored in favor of positive guidance from investor’s favorite tech giants (i.e. FANGS). With both market performance and sentiment concentrated in just a few big names, any large negative surprises among them will affect sentiment, resulting in subdued risk-aversion levels may suddenly becoming unleashed.
Sentiment in developed Europe has found a renewed optimism and is now once more ahead of markets.
Sentiment in Developed Europe has likewise bounced off the top of the neutral zone for both our variants, never quite breaking below that level last week (top chart). Investors are now more positive than they were back in January of this year when worries about the global economy and the developing coronavirus narrative made them turn more cautious.
The Style-ROOF variant shows both risk-tolerance (green line in bottom chart) higher than in January and rising, while risk-aversion (red line in bottom chart) is declining and almost at the January low. Safe for the UK, Europe’s coronavirus narrative is better than that of the US, but with Brexit trade negotiations unsettled, neither the earnings nor the macro picture should be any better for that part of the world. That leaves only the ECB’s market operations as a driving force for optimism. Still, there they are, more positive than negative and giving markets some support for higher levels.
Risk appetite remains split between our two variants, nowhere more so than Asia ex-Japan.
Last week we highlighted the divergence in sentiment between our two ROOF variants (Style-based vs Sector-based) for both global developed markets (top chart) and Asia ex-Japan (bottom chart). This divergence continued to grow last week, especially in Asia ex-Japan where the Style-ROOF has now reached a new YTD high, although the Sector-ROOF in that part of the world seems to have bottomed out. For both markets, risk-tolerance rose, and risk-aversion declined last week, more so in the more optimistic Style-ROOF variant, indicating that investors see nothing to worry about in the upcoming Q2 earnings season.
This divergence is reminiscent of what we saw in May of this year for both markets. At that time, the Style-ROOF variant corrected course to converge on its Sector-ROOF peer while markets rose to catch-up with sentiment. Nothing short of the need for a second lockdown in major markets will shake investor sentiment at this point. Neither growing geopolitical tensions, the worst macro data since 2008, or social unrest, seem to have been able to shake their growing risk-appetite. And, with every CEO holding a get-out-of-jail-free card in their hand for the Q2 earning season, it seems hard to see what could tip markets off their QE-induced highs.