ROOF Highlights — August 2, 2022

Qontigo ROOF™ Score Highlights: Week of August 1, 2022

Potential triggers for sentiment this week1 :

  • US: 148 of the S&P 500 companies will report Q2 results this week. On the macro front, investors will focus on several Fed governor speeches for hints about the size of the next rate hike at the September FOMC meeting, and the July jobs report on Friday.
  • Europe: The Bank of England will raise interest rates again, with forecasts split between a 25- and a 50-bps rise. Eurozone employment and producers’ inflation data to be released.
  • APAC: China July PMI, Reserve Bank of Australia’s interest rate decision.
  • Global: Corporate earnings and monetary policies will continue to drive investor sentiment in the short term, replacing concerns about the war in Ukraine.

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 in the US, Europe and global developed markets, ending the week positive in all three. Sentiment remains negative among investors in global emerging markets, Japan and Asia ex-Japan, with the latter falling back into a bearish mood. Sentiment among Chinese investors is still moderately positive but on a declining trend since late June; recent geopolitics will do nothing to lift it back up.
  • The uncertainty from the current macro and geopolitical situation means that for investors, the future isn’t as reliable as it used to be. Back in March of this year, they felt inflation was well ahead of central banks. Today, they feel it’s a draw. They will need to see evidence that central banks are winning to become positive enough and support a sustainable market rally.
  • The removal of both fiscal and monetary stimuli means investors are operating without the safety net they have become accustomed to, one that had kept equity market volatility well below its long-term median this past decade. They are still inspired by the same capitalist impulses, but since the pandemic, they have become wiser about all the ways that utopian dream can be taken away from them by exogenous factors — especially in the absence of a greater fool in the market (the Fed).
  • The war in Ukraine still rages on, but for now, investors’ graze for frontline news has turned to glaze. Their focus is on inflation, the monetary policy response, and the impact both will have on the economy and corporate earnings. The latter have, so far, been better than feared. Yet, in the face of still too many unknown unknowns, investors worry this remission isn’t going to last — especially since profits have been based on companies’ ability to pass on higher costs as higher prices to consumers, who are increasingly less likely to afford them.
  • Sentiment among Asian ex-Japan investors is likely to suffer further this week as the focus switches from the pandemic’s pox to (Pelosi’s) Pandora’s box, adding another exogenous push towards risk-aversion and turning an already negative sentiment into a bearish one.

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US investor sentiment

Sentiment among US investors (green line) continued to recover, helped by better-than-feared corporate results from big technology firms, ending the week at the most positive level in over a year (July 7, 2021). Breaking above the previous high reached in late November 2021 confirms the recovery pattern for sentiment among US investors, who are now feeling more positive than they have been at any other time this year. They are not yet bullish, however, but the momentum seems to be on the side of a continued rise in risk-tolerance near-term. Medium-term, macroeconomic and geopolitical headwinds remain in place and will dominate the news cycle after the end of the Q2 earnings reporting season, negatively affecting sentiment once again after that.

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European investor sentiment

European investors’ sentiment (green line) followed a similar recovery pattern as in the US, ending the week at its highest year-to-date level, just shy of bullish (+0.44 vs +0.50). Sector allocations (red dotted line) also confirms the implementation of a risk-tolerant strategy by most investors. We attribute this recent surge in sentiment to the positive impact of having the ECB (finally) tackle inflation head-on with a more hawkish monetary policy. The weak euro was also an attraction for foreign investors in European stocks. Risk tolerance is now significantly higher than risk aversion for the first time in almost a year, and should continue to support the market’s recovery, unless some exogenous factor comes along to knock sentiment off its perch.

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Global developed markets investor sentiment

Sentiment among global developed-markets investors (green line) surged further last week, helped by a similar feeling among US and European investors. It ended the week strongly positive, but not yet bullish. Investors have been bearish almost every single week since November 2021, and July marks the first month with four consecutive weeks of rising sentiment, giving the recent market rally some emotional support to keep going. The improvement in investors’ mood can be attributed to the fact that they have been over-bearish for too long, and the current Q2 earnings reporting season is making them reevaluate their forecast upwards to a base case instead of a worst case. Still, the sources of those negative scenarios remain in place and even have the potential of becoming worse in the form of an even more adversarial US-China relationship in the coming weeks. In this context, it is perhaps best to think of the recent rise in sentiment as simply an improvement on a previously very negative view of things — one might call it just cautiously hopeful.

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Asia ex-Japan markets investor sentiment

Sentiment among Asia ex-Japan investors (green line) has been under pressure since recovering in May following the end of a prolonged lockdown in major cities in China. June brought investors back to a bearish mood, and sentiment has remained there during July, unable to recover as it did in developed markets and ending last week bearish once again. Increased US-China tensions will do nothing to assuage an already bearish investor sentiment worried about another property debt crisis in China. Investors’ sector allocation (red dotted line) points to the rapid implementation of bearish strategies in the past two weeks. Risk aversion remains higher than risk tolerance but the imbalance between the two isn’t wide enough to cause a sharp overreaction unless there is a material deterioration in sentiment. For now, without knowing what China’s response will be to the potential trip to Taiwan by Speaker Nancy Pelosi, investors seem to be preparing for the worst.

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Global emerging markets investor sentiment

Sentiment among global emerging-markets investors (green line) ended the week at the same neutral level of the previous week. The recovery pattern in sentiment ended in early June, when a declining trend begun. This turnaround put an end to the market’s recovery and sent it back into a losing trend. The sector allocations (red dotted line) point to the implementation of bearish strategies by investors since mid-July. With risk aversion once again above risk tolerance levels, the net negative risk appetite is unsupportive of a market rally. If sentiment continues to deteriorate, markets could retest recent lows in the near term.

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Japan market investor sentiment

Sentiment among Japanese investors (green line) recovered slightly last week but still ended negative. The strong recovery in April and May following the end of Covid-19 related restrictions, failed to hold and sentiment has been on a downward trend since early June. This has prevented markets from recovering their previous high-water mark in January. Sentiment is currently neutral but slightly negative, with risk aversion higher than risk tolerance. This will prevent any rally from reaching new highs until sentiment recovers. Consumers and retail investors in Japan remain pessimistic about the future given the BoJ’s inaction towards rising inflation. Investors will have to wait until October to hear from CEOs how they have benefitted, if at all, from the sharply weaker Japanese yen. Until then, geopolitics is likely to be the main driver of sentiment.

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China (domestic) investor sentiment2

Sentiment (green line) among Chinese (A-shares) investors ended last week virtually unchanged from the previous week — still positive, but well off its bullish highs of early July. The bottoming out of sentiment seems to have ended in early July with investors becoming progressively less positive each week. Sector allocations (red dotted line) point to an implementation pivot from risk-tolerant strategies in May and early June to risk-averse ones in late June and July. Risk aversion remains lower than risk tolerance but the gap between them has narrowed to a more neutral position in recent weeks as investors await cues from the geopolitical sphere as to which way the US-China relationship will evolve. Positive vibes from the possible removal of some trade tariffs to alleviate inflationary pressures in the US have given way to worries about a strong (Chinese) military response to a potential trip by Mrs. Pelosi to Taiwan this week. As always in China, politics will trump economics when it comes to investor sentiment.

2 Note that as of the end of May 2022, we have switched to using a core benchmark as estimation universe instead of the broad market portfolio to better capture the behavior of institutional investor by removing the small caps from our analysis.

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