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ROOF Highlights — December 5, 2022

Qontigo ROOF™ Score Highlights: Week of December 5, 2022

Potential triggers for sentiment this week1 :

  • US: Non-Manufacturing PMI, University of Michigan’s consumer sentiment index, PPI data.
  • Europe: Eurozone final Q3 GDP and retail sales, German factory orders.
  • APAC: China CPI.
  • Global: Macro factors are top of mind for investors, who remain focused on their implications for global monetary policy.

Summary of changes in investor sentiment from the previous week:

  • Investor sentiment continued to recover last week in all markets we follow, except China and Asia ex-Japan, where investors remained bearish. Sentiment ended strongly positive among investors in Europe, Japan, and the US, with the former turning briefly bullish on Thursday. Sentiment among global developed- and global emerging-markets investors ended neutral, held back by ongoing currency volatility in the former and the fluid COVID-19 situation in China in the latter.
  • Since mid-October, the recovery in sentiment has looked so much like the recovery in markets that it almost feels like sarcasm. Average traded volumes remain well below their levels from the first half of the year, making this recovery seem like a minority opinion based on a) a Stockholm syndrome centered on central banks’ hawkish monetary policies, and b) a strong belief that most other investors are, well, wrong about the stagflation consensus scenario.
  • This (faith) ‘haves and have-nots’ situation indicates that most of the investors who remain on the sidelines view the pivot theory with a heathy dose of skepticism. So, if the current sentiment represents only how half of investors feel, what does the full picture look like? And is the pivot theory the type of investment thesis that – when afforded the luxury of time – slowly becomes romantic in the eyes of undecided investors who then join the market?
  • The relationship between markets and the economy is effortless to appreciate in the abstract but hard to describe in the specific. At times bad news is good news, allowing a contrarian theory to grow in popularity. Last week’s stronger-than-expected news from both the jobs report and wage growth data in the US, could mean good news is bad news for most investors, sending both markets and sentiment in reverse this week.
  • Investors are back to where they were in late August, having to decide between being potentially, objectively, collectively wrong (i.e., falsely believing in a central bank pivot based on a single data point), or being subjectively, collectively wrong (i.e., choosing to remain on the sidelines until clarity returns to the picture). Sentiment momentum seems in favor of the former between now and the Fed’s rate decision meeting on December 13-14.

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US investor sentiment

Sentiment among US investors (green line) surged last week, jumping from negative at the end of the prior week to end increasingly positive last week. Risk aversion fell below risk tolerance for the first time since August as both markets and sentiment continue to benefit from signs that the Federal Reserve will switch to smaller rate increases from their December meeting onwards. Stronger-than-expected economic data released late last week could, however, raise the destination at which interest rates will stop rising, and prolong the current hawkish cycle in the mind of many investors, who might then see the current rally as a good profit-taking opportunity. Markets and sentiment remain below their previous (August) highs and will need more participants to break above this recent high-water mark.

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European investor sentiment

European investors’ sentiment (green line) rose again last week, reaching its highest level since early August on the back of an improving inflation outlook. The ECB was quick to reiterate that a single positive data point was not enough to conclude that inflation has peaked and that the current level of 10% is still well above its target. An increasingly positive risk appetite, combined with lower volatility and low volume, led to a positive knee-jerk reaction by investors. Markets and sentiment have now regained their August high-water marks and seem to have the momentum to continue to rise in the short term.

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Global developed markets investor sentiment

Sentiment among global developed-markets investors (green line) improved slightly last week, ending neutral from mildly negative the prior week. The rising optimism of global developed investors has lagged that of US and European investors as currency volatility remains a headwind for them. Globally the inflation picture seems to have improved, but the fate of the global economy remains highly uncertain given the ongoing COVID-19 situation in China, the war in Ukraine and ongoing supply chain disruptions in the technology industry. Sentiment should continue to improve, cautiously, but the economic headwinds are too many to ignore, forcing most investors to the sidelines, awaiting clarity on how much higher interest rates will rise and what costs this will extract from the economy.

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Asia ex-Japan markets investor sentiment

Sentiment among Asia ex-Japan investors (green line) improved slightly last week, ending bearish for the second week in a row but off its lows. The COVID-19 situation in China continues to be the main factor affecting sentiment in the short term. Last week saw several signs that the authorities are working to limit a further negative impact on the economy form safe-distancing restrictions. Further fiscal and monetary assistance to the highly indebted property sector also helped sentiment improve by keeping risk aversion in check. Any improvement from current levels will require more details and clarity on the policy response to still rising COVID-19 infection rates.

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Global emerging markets investor sentiment

Sentiment among global emerging-markets investors (green line) improved slightly last week, ending neutral from negative the prior week. Emerging markets continue to suffer from unpredictable currency movements driven by commodity markets and geopolitics, the COVID-19 situation in China, higher US interest rates, and a stronger US dollar. Global emerging economies rely on the health of the economic demand in global developed markets, which is itself in doubt given the inflationary pressures and hawkish monetary policies in place. Investors’ neutral sentiment is driven more by a fall in their risk aversion than a rise in their risk tolerance. In this situation, any risk event could force risk aversion levels back up, and tilt risk appetite down. Conversely, it will take a few consecutive reassurances on the global economic front for risk tolerance to rise again. Net risk appetite has recovered the neutral levels of July and early April of this year, but risk tolerance remains well below what it was both times and is indicative of a lack of confidence. 

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Japan market investor sentiment

Sentiment among Japanese investors (green line) rose slightly last week, ending strongly positive for the second week in a row. Investors are cheering the strengthening yen from oversold levels against the US dollar, a still dovish central bank at home, and lower market risk levels. Japan is the only market we track where average traded volumes have returned to their long-term average levels, indicating that Japanese investors are more confident about the market rally than in other markets. Still, two metrics seem to contradict the possibility of either sentiment or markets improving further from here. First, risk tolerance has begun to rise again as some investors rotate into risk-averse assets. Second, absent the decline in market risk, the sector allocation decisions (red dotted line) continue to favor risk averse sectors, implying that the recent market rally was driven mostly by the implementation of risk-averse strategies and not risk-tolerance ones.  

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China (domestic) investor sentiment

Sentiment (green line) among Chinese (A-shares) investors remained bearish last week, ending just below the prior week’s level. Positive signs from the authorities that they are trying to limit the impact of COVID-19 policies on the economy failed to lift sentiment as most investors feel that the damage may already be done. Economic data released so far show an economy slowing much faster than predicted, and a recent (rare) flurry of social unrest may signal that the financial stress on consumers may be even higher than previously thought. The uncertainty surrounding the COVID-19 response situation, the domestic and global economic growth trajectory, as well as the ongoing geopolitical tensions, will ensure that sentiment remains under pressure, limiting any market rallies in the short term. Risk aversion remains well above risk tolerance among domestic investors, making them more prone to a downside overreaction in the event of negative news.

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

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