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ROOF Highlights — April 12, 2021

Qontigo ROOF™ Score Highlights: Week of April 12, 2021

Potential triggers this week: First-quarter earnings season gets underway, with major banks JPMorgan, Citigroup, and Wells Fargo. On the economic data front, US Inflation, US and Eurozone retail sales and industrial production figures; UK monthly GDP; China Q1 GDP and trade balance.

Summary: Investors go about the business of expressing their views through the trappings of their cognitive biases about what could happen rather than through the reality of what did happen. Throughout Q1 2021, this cognitive bias turned increasingly negative, reflecting the expectation that something very bad could happen. As it turned out, nothing bad did happen, failing to trigger an over-reaction on the downside as a result. This negative bias had mostly macro undertones caused by fears of inflation and further lockdowns. With the Q1 earnings season upon us, the main driver of sentiment will switch to the micro view and how individual companies weathered the second wave over the winter and – more importantly – their predictions for the rest of the year. In preparation, sentiment in all markets has recovered and ended last week in neutral. The neutral zone is a place where the depth of investors’ hopes (or fears) does not exceed the thickness of their skin. So, while some valuations are high, expectations do not seem to be, making an over-reaction unlikely.

US markets seem in Déjà vu mode with sentiment following a similar pattern of recovery.

For the second time in less-than nine months, sentiment is staging a recovery from the bearish zone. Both ROOF ratios have regained the neutral zone over the past three weeks, fears about the macro situation diminished (top chart). This same pattern was observed in November last year, albeit then, it took multiple vaccine news to lift sentiment back up. This time around, additional fiscal stimulus, the promise of continued asset purchases by the Fed, and optimism with regards to the upcoming earnings season seem to have calmed investors.

As it did back in November last year, risk aversion (red line) continued to decline, while risk tolerance (green line) continued to rise, all but closing the imbalance between the demand and supply of risk among investors (bottom chart). In this state of near equilibrium, the want isn’t superior to the need and risk assets should trade based on fundamentals and news flow from corporate earnings.

European investor sentiment leads other regions to the top of the neutral zone.

Both European ROOF Ratios continued their strong rebound off the bearish zone a month ago to reach the top of the neutral zone (top chart). In this state, investors are cautiously optimistic, and the cognitive bias is becoming increasingly positive. A similar pattern emerged last December, and their growing optimism was rewarded with a post Brexit trade deal which helped carry sentiment into the bullish zone before the second wave of infections brought it back down again.

This time, hopes are pinned on a global economic recovery and it will take a third/fourth wave of infection and their associated lockdowns to dim their outlook. Risk aversion (red line) has been dropping fast, and risk tolerance (green line) rising quickly, tilting the supply and demand balance for risk increasingly in favor of demand (bottom chart). Markets have been anticipating this recovery in sentiment and seem to have already priced it in, refusing to fall with sentiment in February.

Global and Asia ex-Japan investor sentiment recovery settles in the Neutral zone.

The recovery in sentiment from global investors stalled last week to trend sideways within the neutral zone, indicating that investors no longer fear the worst but need further reassurance to start believing in the best outcome for the global economy (top chart). Back in Q4 2020, the vaccine and Brexit news helped sentiment recover all the way to the bullish zone but this time, it seems investors will require more than words to raise their spirits further.

Meanwhile, in Asia ex-Japan, sentiment is now back to equilibrium at the center of the neutral zone (bottom chart). Investors’ lack of confidence and negative cognitive bias has been holding markets back below their February highs in that part of the world, perhaps now, with improving sentiment, positive earnings news can lead to higher markets, but the threat of negative geopolitical headwinds from the4 US-China relationship remain a drag on sentiment.