ROOF Highlights — April 25, 2022

Qontigo ROOF™ Score Highlights: Week of April 25, 2022

Potential triggers for sentiment this week1 :

  • US: Busiest week of the corporate earnings season, with many mega-caps and big tech companies reporting. On the macro data front, preliminary estimate for first-quarter GDP, PCE expenditure price index and several housing market updates.
  • Europe: The largest economies including Germany, France, Italy and Spain, will be publishing their preliminary estimates of first-quarter GDP and inflation rates.
  • APAC: In China, earnings take center stage with results coming from major oil companies Sinopec and PetroChina, and financials China Life Insurance and Bank of China. Covid-19 related lockdowns will also continue to weigh on investor sentiment. In Japan, key labor market, industrial production and retail data will be released before the Bank of Japan meets to decide on interest rates.
  • Global: Russia’s declaration of its intention to control both the east and the south of Ukraine means this war is far from over and will continue to weigh on sentiment, along with rising inflation and higher interest rates.

1 If sentiment is bearish/bullish, a negative/positive surprise on these data releases could trigger an overreaction.

Summary of changes in investor sentiment from the previous week:

  • Investor sentiment continued to recover from its bearish lows reached in early March, ending the week mostly neutral in all markets we track. Hopes (now dashed) for an early end to the war in Ukraine, as well as declining levels of market risk were the key drivers behind the recovery in sentiment. Nevertheless, sector allocations are already starting to hint at a reversal.
  • Investors began the year worrying about the negative impact that both higher inflation and interest rates could have on financial markets. The war in Ukraine exacerbated both of those and introduced a third worry — that an increasingly hawkish monetary policy by major central banks to tackle inflation might push their economies into recession next year.
  • The inflation, interest rates and recession worries are all still here. Only a lower market risk and mounting evidence that Russia’s invasion of Ukraine wasn’t going according to the Kremlin’s plan, drove the recovery in sentiment. Last week ended with the Kremlin changing their plan, indicating they now ‘only’ seek full control of the east and south instead of the entire country.
  • This latest strategic pivot by Russia will keep Ukraine at the top of headlines, potentially turning an already bleak narrative for the country into an apocalypse in slow motion. Daily headlines of ominous encounters by Ukrainian civilians with one or more of the legendary Four Horsemen, could lead to an escalation with a more direct involvement by NATO.
  • Investors know Putin must be stopped. If not by his own volition, then by compulsion. The question on everyone’s mind is which one will come first, and at what cost. This must be answered first, before investors can put any faith into economic forecasts for the rest of the year and beyond. And so, neutral is probably the best they can feel, making sustainable market rallies unlikely in the near term.

US investor sentiment

US investor sentiment (green line) ended the week flat after its recent recovery. Calls for more aggressive hikes in interest rates to fight the highest inflation in decades, together with a resurgence in the war in Ukraine outweighed what has so far been a mostly positive earnings reporting season. Despite a recovery in sentiment, investors have started to implement mostly risk-averse sector allocations since the start of the month (red dotted line). Thus, only lower market volatility (compared to levels in March) is in favor or risk tolerance. This week will be the busiest in the reporting season for mega-caps in the US and will also see the first set of macro data (Q1 GDP estimates) covering the period since the war in Ukraine started. If both confirm a strong economy and resilient profit margins, sentiment should remain flat, allowing markets to recover some of last week’s losses, but, more hawkish calls from the Fed as well as a deteriorating situation in Ukraine, could trump lagging earnings and economic data and send investors back into a bearish mood.

European investor sentiment

European investors’ sentiment (green line) continued to rise last week, ending perfectly neutral. The recovery in sentiment started about two weeks after the recovery in the US and may still be reacting to the decline in market risk and the positive earnings season thus far. The ECB’s reassurance that they were not considering raising interest rates soon has also helped investors regain some risk tolerance and implement more bullish strategies via their sector allocation (red dotted line). Both have supported markets, which managed to hold on to the gains made in March. This resurgence in risk tolerance will be severely tested this week as the war in Ukraine enters a new phase of more focused fighting on the eastern and southern fronts. Currently the demand and supply for risk are evenly matched but remain subject to the evolving inflation and war narratives. There is a feeling that we may have seen all the improvement in sentiment that is available given the macro circumstances surrounding the European markets.

Global developed markets investors sentiment

Sentiment among global developed-markets investors (green line) rose for a third straight week, ending neutral for the first time since late February. As with other markets, though, most of the recovery in sentiment can be attributed to falling volatility levels, but the sector allocation (red dotted line) continues to indicate that investors are implementing risk-averse strategies rather than risk-tolerant ones. For global investors, the war in Ukraine has increased both currency and country risk and with the US market and the USD attracting most of the safe-haven inflows, this means fewer opportunities for risk diversification and higher costs for being wrong, forcing many into defensive strategies. The demand and supply of risk assets is back to more balanced equilibrium, but this is mostly from a reduction in supply rather than a rise in demand. Any negative news on the key points of inflation, interest rates, economic growth or the war in Ukraine will send risk-aversion levels back up and increase the supply of risk assets at a time of weak demand.

Asia ex-Japan markets investor sentiment

Sentiment among Asia ex-Japan investors (green line) continued its recent rise to end the week neutral and at the highest level since late November. The recovery in sentiment, if sustained, could Sentiment among Asia ex-Japan investors (green line) surged for the third consecutive week, ending neutral but on the positive side of the neutral zone (between 0 and +0.5), on continued pledges from Chinese regulators to support the economy. The negative reality of the long COVID-19 lockdowns in major cities across China, however, is contributing to the ongoing popularity of risk-averse strategies (red dotted line). It seems that more than words will need to be given to investors for them to start implementing more risk-tolerant strategies. Regional markets still face the triple demerits of slower global growth, higher US interest rates, and a stronger USD, all of which act to raise the cost side of the ledger and deflate the revenue side for Asian corporates, and limits the flexibility of their regulators to apply monetary or fiscal stimuli.

Global emerging markets investor sentiment

Sentiment among global emerging-markets investors (green line) rose slightly last week, ending (seemingly temporarily) bullish for the first time since November last year. The mood among emerging-markets investors is usually heavily influenced by the mood of Chinese investors, and for this reason, the recent rise in investors’ sentiment may be temporary as that of Chinese investors is already turning down (see below). The rise in commodity prices, US interest rates and the USD will hit emerging economies the hardest, and the longer the war in Ukraine goes on, the longer these pains will affect both corporate earnings and markets in those parts of the world. Conscious of this, sentiment is likely to head back into neutral soon and cap any market rallies.

Japan market investor sentiment

Sentiment among Japanese investors (green line) rose sharply last week, ending positive and at its highest level since November last year. This has helped the Japanese market fare better than its peers last week, capitalizing on the weaker JPY that benefits exporters. The safe-haven strength of the USD is linked to the situation in Ukraine, and if this persists longer than expected, it will continue to be a source of support for both markets and sentiment in Japan. This technical support, however, may mean lower downside risk but not necessarily higher upside potential. The macro and the geopolitical situation must both improve for the upside to have a real chance.

China (domestic) investor sentiment

Sentiment (green line) among Chinese (A-shares) investors ended down for the week as the economic reality of the lockdowns across major cities overshadowed positive signals from regulators for supportive measures. The decision by the BoC to leave interest rates unchanged last week also disappointed investors who were looking for more support from the central bank. Investors had been gradually implementing more risk-tolerant strategies since the start of the year (red dotted line), but failed to be rewarded for those with positive market returns. Starting two weeks ago, they have been unwinding some of these risk-tolerant bets and implementing more risk-averse strategies instead. This is a pattern that might continue in the short term due to a lack of tangible supportive regulatory moves and ongoing lockdowns across the country.