ROOF Highlights — February 1, 2021

Qontigo ROOF™ Score Highlights: Week of February 1, 2021

Potential triggers this week: The week will end with the critical US jobs report which showed its first weakness in 8 months in December. Further weakness in January means the Fed will remain accommodative, a sharp rebound risks spooking investors. Continued haggling over the fiscal stimulus package will also keep investors on edge. Earnings from Alphabet, Amazon, Exxon Mobil, and Pfizer, as well as Eurozone GDP figures and BoE policy decision will also weigh on sentiment.

Summary: Investors have emotions, a (bad) temper, and, apparently, agendas. Investor sentiment in the US, global developed markets, and Asia has been trying to convince markets they were wrong to keep rising, and that the premiums being paid for risk assets ran counter to investors’ deteriorating risk appetite.  Last week, markets heeded the call. Sentiment has been mirroring the weakening economic recovery while valuations were chasing the now familiar impact stimulus checks have on popular online businesses. Conversely, in Europe, sentiment and markets have been rising together since late November. Last week sentiment receded for the first time in three months, taking markets down with it. The week ended with US and global developed investors neutral, Europeans still bullish but recedingly so, and Asian investors increasingly bearish.

Markets and sentiment in the US may be headed for a truce after a long disagreement.

Both ROOF Ratios halted their month-long decline last week regaining some cautious optimism as the growing gap between sentiment and markets finally narrowed (top chart). Investor sentiment reflected the damage a rising infection rate and associated measures to stop it will have on the broad economy in the first half of 2021. Market valuations, meanwhile, focused on the boost to earnings new stimulus checks would have for popular and newly identified pandemic profiteers.

Conflicted by these two opposing pressures, the supply-and-demand balance for risk settled at equilibrium last week with risk tolerance and risk aversion levels evenly matched (bottom chart). In this state, sentiment is unable to give markets much direction and, as was the case last September-October, the latter tends to trend sideways in a narrow range until further guidance is given. This will have to come in the form of an actual fiscal stimulus package, not just talk of one.

Sentiment in Europe starts to weaken and takes markets down a notch with it.

Investor sentiment halted its two-months long surge and took markets down with it (top chart). Both ROOF Ratios are still well into the bullish zone even after last week’s correction, but a pause in sentiment (even at these high levels) could leave markets directionless for a while, as it did last summer.

The strongly positive imbalance between the demand and supply for risk has weakened last week but remains heavily in favor of risk-tolerance (bottom chart). Still, sentiment seems to have recovered based on the premise of better (economic) days brought on by both the vaccine news and a successful post-Brexit trade agreement between the UK and the EU, now comes the hard part. Investors are demanding to see the proof in the pudding they’ve been sold and will remember all too well last summer’s failed promises from the early reopening in May.

Global Sentiment unwilling to bet against markets but sticks to its (bearish) guns in Asia.

The gap between markets and sentiment narrowed further last week for global developed market investors, this time with markets making most of the move (top chart). Sentiment may be entering a prolonged undecided phase as it did last September, keeping markets range-bound until convincing and impactful news comes along to sway it one way or the other.

Markets finally succumb to sentiment in Asia ex-Japan with an overdue correction (bottom chart). Sentiment, meanwhile, deteriorated further and the Sector ROOF (green line) is now in bearish territory pulling its Style ROOF (blue line) counterpart in tow. The month-long divergence between valuations and sentiment has created quite a lot of downside risk if the latter does not recover to meet markets half way. Stimulus checks in the US will help, but at this point, sentiment seems more focused on the deteriorating US-China relationship than export volumes.