ROOF Highlights — February 28, 2022

Qontigo ROOF™ Score Highlights: Week of February 28, 2022

Potential triggers for sentiment this week1 :

  • US: Biden’s first State of the Union speech to Congress, congressional testimony from Fed chief Powell, and non-farm payrolls. 
  • Europe: ECB president Lagarde’s speech, and Eurozone inflation data.
  • APAC: China manufacturing PMI data.
  • Globally: the ongoing invasion in Ukraine and retaliatory sanctions.

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 remained bearish last week in most markets we track, recovering only slightly among global developed-markets and Chinese investors, but remaining very negative there too. The situation in Ukraine and its ongoing ramifications in terms of successive retaliatory responses and their potential binary impact on inflation, global growth, and the current direction of monetary policy, will keep investors on edge in the short term.
  • Volatility is the child of uncertainty, not its parent. The uncertainty from if and when an invasion of Ukraine by Russian military forces would take place, has now given way to uncertainty from what happens next, and how will it end? The binary nature of these questions and the lack of clarity as to their potential impact, is enough to make any investor feel like a nosy accountant running an audit while someone is trying to hide the books.
  • What was first expected to be a regional military conflict, now has the potential to become a more global economic one as a result of successive retaliatory sanctions. Inflation has been mostly driven by rising energy prices, and given Russia’s influence on oil and gas markets as a major producer (and exporter), these pressures are now likely to increase. The question for investors is, will this upward pressure be countered by downward pressures on global growth from growing retaliatory sanctions? And how will central banks react?
  • Sentiment will remain hostage to the ongoing uncertainty from the Ukraine situation, and while there is still hope for a short-term end to the military conflict, the geopolitical one will go on and dominate both national and international politics for months to come, creating yet another set of uncertainties for investors.
  • Russia has already become a key topic of discussion for the upcoming French presidential elections, the US midterms, and US-China relations. Gone, it seems, are the days when the US media could spend an entire year discussing nothing but Monica Lewinsky or O. J. Simpson. The question already being raised by some economists, is whether the events of last week mark the official start of Cold War II? If so, after decades of peace, investors will need to dust-off a very old playbook to navigate the next few years.

US investor sentiment:

US investor sentiment (green line) remained deeply bearish last week, and has now failed to show any significant signs of improving for two consecutive months. With the Russia-Ukraine conflict throwing a wrench in macroeconomic modeling, uncertainty will continue to remain high, providing a lack of support for any return to positive sentiment in the short-term – investors cannot become positive about a forecast they cannot make or rely on. The fluidity of the current geopolitical situation and investors’ bearish sentiment means that they will continue to overreact to negative news and underreact to positive ones, keeping market volatility elevated in the short term.

Risk aversion (red line) rose last week in response to the developments in Ukraine, and risk tolerance (green line) gave back the gains from the previous week. Net risk appetite is now highly negative with potential sellers outnumbering potential buyers by more than two-to-one. Investors should expect a strong negative overreaction to further negative news. This could come as early as Tuesday with President Biden’s State of the Union speech, or Wednesday with the congressional testimony from Fed chief Powell. Friday’s job report, by comparison, is seen as a lagging indicator now.

European investor sentiment:

European investor sentiment (green line) remained unsurprisingly bearish, considering recent military developments on the region’s eastern front. A sustainable market recovery looks unlikely with the current bias being to overreact to negative news and underreact to positive ones. Nothing short of a return to peace will allow sentiment to recover. Investors are not picking sides, they are simply saying that short of being able to model a reliable forecast on everything from macroeconomics to corporate earnings, they simply cannot balance risk and reward, leaving only risk as the decision factor. As the daily denouements, so far, lead us ever further way from peace instead of towards it, they clearly expect uncertainty and volatility to remain too high to return to markets.

The start of military hostilities in Ukraine last week led to a rebound in risk aversion (red line) levels, although those remain far below their recent highs. Risk tolerance (green line) ended the week slightly higher but remains near its lowest levels in more than a year, resulting in a still sharply negative net risk appetite across developed Europe market investors. In the current situation, there is still more downside risk than upside potential for markets as investors continue to focus more on negative news than on positive ones.

Global developed markets investors sentiment:

Sentiment among global developed-markets investors (green line) continues to benefit from multi-country diversification and ended last week just above the bearish line but still very negative. Investors have been hoping the military conflict in Ukraine might prevent a stronger hawkish stance from major central banks by way of slower growth and have been rebalancing their portfolios accordingly for the past two weeks. This week’s speeches by both the ECB president and the Fed chair should give them clues as to the possible impact this conflict will have on monetary policy. Sentiment remains quite negative, even after the recent rise in the past two weeks, and investors can best be described as hopeful but not yet optimistic.

Risk tolerance (green line) continued to rise last week while risk aversion (red line) continued to decline, ending the week at recent lows. As mentioned in the previous week, the rise and fall in sentiment has been mostly driven by changes in investors’ risk aversion rather than their risk tolerance. Given current uncertainty levels, investors will continue to focus more on downside risk prevention than upside return potential.

Asia ex-Japan markets investor sentiment:

Investor sentiment (green line) in Asia ex-Japan has been bearish since mid-December and has remained in that state of mind for the past two months, despite low valuations relative to developed markets. The region’s markets are affected mostly by global growth prospects and the direction of US monetary policy. Both have recently turned negative, and a military conflict in Ukraine, threatening to exacerbate the situation, will do nothing to improve sentiment. Investors will pay close attention to speeches from central bankers this week, as well as further clues on the nature and potential impact of any further retaliatory sanctions against or from Russia, if and when they come.

Risk tolerance (green line) continues to slowly recover from its lows but is not keeping pace with the recent rise in risk aversion (red line). The latter has accelerated with the events of the last few days. Net risk appetite remains very negative and driven mostly by changing levels of risk aversion rather than risk tolerance. Uncertainty levels remain too high for risk tolerance to be able to rely on credible forecasting, risk aversion, on the other hand, only requires adequate risk prediction to rise.

Global emerging markets investor sentiment:

Sentiment among global emerging-markets investors (green line) was mostly flat last week and remains bearish. Unlike their developed-markets counterparts, emerging-markets investors only turned bearish at the start of February, and a full year of underperformance has kept valuations relatively low. Sector allocation (red dotted line) points to a more neutral sentiment, meaning that the bearish sentiment is mostly driven by rising volatility and the need to de-risk portfolios, rather than a bearish outlook. If scheduled talks between the Ukraine and Russia this week lead to a ceasefire, this could be enough to deflate current volatility levels and allow investor sentiment to recover the neutral zone, even if temporarily. Much will also depend on the direction of monetary policy in the US and EU and the outcome of this week’s speeches by the ECB and the Fed.

Risk aversion (red line) resumed its rise last week after the start of hostilities between Russia and Ukraine, while risk tolerance (green line) remained flat. Risk aversion levels, while not at new highs, remain elevated and are still the main driver of sentiment. Rising volatility levels translate into higher potential losses and given the inability to rely on any positive forecasts on the return side of the ledger, risk will remain the primary concern for investors in the short term.