In the news this week: Not a lot of market-moving economic or corporate news due out this week. In any case, it seems unlikely that anyone will pay attention to news headlines that do not contain the term “corona virus” in them!
Summary: For weeks now, ROOF Ratios have acted like a smoke alarm whose job it is to let people know when and where there is a fire, not how to evacuate the building. For the first three weeks of February, markets treated signs of rising risk aversion as aberrations; lightning from a clear blue sky. In the three weeks following this cognitive dissonance, they have gone from cocky ignorance to miserable uncertainty, as if the virus itself had come to skewer their hubris for attempting to make a positive forecast. This week’s ROOF ratios don’t seem to say that the situation is completely hopeless, but they don’t seem very hopeful either. Perhaps it is ‘regret’ that they point to now? Psychologists describe regret as an emotion born from experience (i.e. having invested when risk was high, and confidence was low) that leads a person to avoid punishment in the future (i.e. don’t do that again!). If this is true, it may take more than a few sanitizing days for the balance between the demand and supply of risk assets to return to equilibrium.
- Sentiment in the US joins Japan and Developed Europe ending last week in bearish territory (ROOF Ratio <-0.5) as Covid-19 cases there rise and begin to affect businesses.
- All other markets remain in the neutral zone, where they have been for some time, and will continue to take their cues from CNN.
- Volatility and uncertainty continue to rise and impede investor’s ability to forecast returns. In the face of rising expected losses from stress test with updated volatility and correlation inputs, risk appetite should continue to remain too low for a market rally to be sustainable.
- Sentiment is weak (weakest in developed Europe, Japan and the US) but it isn’t yet at new lows (all three reached -1.0 in Q4 last year) indicating that investors are still torn between their fears and the alure of sharply lower valuations, although the latter is now in doubt.
- The economic impact of Covid-19 is still on the ascendency making earning forecasts a moving target. Concerted monetary and fiscal stimulus should cushion the blow for investors.
Sentiment in the US headed for bearish territory last week and is forecasted to cross into it this week.
US ROOF ratios dipped further into negative territory ending the week against the bearish indicator line (-0.5) without crossing it but are forecasted to dip into bearish territory during the week. The daily ROOF Scores show that last Friday saw the highest risk aversion and lowest risk tolerance scores in the last four years (risk aversion was last higher on Feb 9th, 2016). Given that much (>2-standard deviation) negative confirmation bias, it is not surprising to see the kind of over-reaction we saw Monday on the back of negative news. With risk tolerance this low, it will take a while before a rally becomes sustainable.
Both the spread and the economic impact of the Covid-19 outbreak continues to rise and will make forecasting earnings a very difficult task for weeks to come. In the meantime, investors are hoping for concerted monetary and fiscal measures to cushion the blow but given their strong negative confirmation bias, communication around these measures needs to be done with the utmost care – the goal is to calm, not frighten (or bullie).
Sentiment in Japan remains in bearish territory, albeit barely, and is forecasted to remain in this unsupportive state this week.
Japanese investors remain bearish and continue to have a negative confirmation bias. Beyond the threat to the economy from the viral outbreak, the sharply stronger JPY and news of several international sporting events being canceled around the world are acting as triggers for this bearish sentiment. Monetary stimulus would only hurt banks and insurance companies at this point so the rising risk tolerance sub-score we see in the daily ROOF Scores seems to be expecting another massive stock purchase program by the BoJ.
In this bearish state of mind, investors need to be given a reason not to sell and are unlikely to be moved by reasons to buy. The negative confirmation bias means that they expect the impact on earnings to confirm their worst fears. They will need to wait until after the April-May earnings season and the revised analysts’ forecasts to find out.
Sentiment among global developed market investors remains on a downtrend and seems headed for bearish territory.
Sentiment in global developed markets continues to weaken in tandem with all others but remains in the lower half of the neutral territory for now. Here too, rising risk aversion is the main driver of fear, not falling risk tolerance. This is typical of a market in which investors are looking with skepticism at their previous earning forecasts and valuations but are not yet ready to completely discount them. In the meantime, the available news about the worsening impact of the Covid-19 outbreak makes them react to their bearish confirmation bias.
A global pandemic means that cross-country correlations are high and therefore diversification low. Global investors will likely see their active risk levels rise and will need to see a concerted monetary and fiscal response instead of finger-pointing and unilateral decisions that may help one country at the cost of another in their portfolio. Short of that, the sentimental trend isn’t our friend here.