ROOF Highlights — January 24, 2022

Qontigo ROOF™ Score Highlights: Week of January 24, 2022

To add color to this edition of the Weekly Highlights, Olivier d’Assier—Head of Applied Research for APAC and our ROOF market-sentiment specialist—takes a timeout to reflect poetically on the challenges affecting investor’s mood today. Check out his work, “Guess Who’s Coming to Our Dystopian Dinner?”>

Potential triggers for sentiment this week1 :

  • US: earnings season continues with Apple and Microsoft, Q4 2021 GDP numbers, Fed meeting on interest rate policy.
  • Europe: Eurozone and UK PMI data, German and French Q4 2021 GDP estimates.
  • APAC: China industrial profits, Japan PMI data, Hong Kong Q4 2021 GDP estimate.

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:

  • Welcome to dystopia. Investor sentiment remains bearish in all developed markets and Asia ex-Japan. It has recovered only slightly in global emerging markets, Japan, and China, but has stayed negative there too.  
  • The strength of the bearish sentiment is turning markets into a version of nature without nurture: no paralysis by analysis, no secret handshakes — just get out and get out now. Investor sentiment has always been a divided self (bullish or bearish), but this is the first time since the COVID 19 crash of March 2020 that Mr. Hyde has so openly been given the floor.
  • The sharpness of the declines has a feeling of hysteria: hysteria about inflation, hysteria about higher interest rates, hysteria about Ukraine. But all hysteria does is sustain itself until it eventually exhausts itself. The history of the ROOF scores confirms that moments of extremes — either hysteria or euphoria — are just that: moments; and do not usually have lasting power.
  • The question for investors now is whether this was the first shoe or the second one (with the first having fallen last September)? It is always darkest before dawn, as the saying goes, and the trifecta of inflation, hostile geopolitics, and an ongoing pandemic will continue to weigh heavily on sentiment in the short term, but …
  • The Fed and the BoE are on the inflation case with upcoming interest rate hikes. Omicron may have helped us move from a pandemic present to an endemic (near) future. Diplomacy may yet win the day in Ukraine (what upside is there really in a war?). Any of these positives could lift this darkness and presage dawn for investors.
  • There is still plenty for investors to worry about in the medium term, but in the short term, they will be looking for clues among the slew of earnings reports for any hints that inflation has altered consumers’ spending habits in a way that might negatively affect corporate profits.

US investor sentiment:

US investor sentiment (green line) declined to new 52-week low last week, implying an increasingly bearish outlook. At these levels, sentiment is so pessimistic that overreaction to negative news is almost immediate. Any hint of danger to corporate earnings is instantly punished by outsized sell orders (e.g., Netflix -22%, Peloton -24%, Shopify -14%, Walt Disney -7%, etc.). Note that these stocks were among some of the biggest pandemic profiteers, but they were also ‘nice-to-have’ services, not ‘must-have’ ones. It is possible that their steep price falls implies investors have become so worried about inflation, they fear consumers will now have to cancel ‘nice-to-have’ services to pay for groceries. In the short-term, sentiment remains bearish and investors prone to more downside overreaction to ongoing negative news. It will take several consecutive days of a positive narrative to make bargain-hunting the new consensus view. Another positive trigger for improving sentiment would be declining inflation, but the next reading in the US isn’t until February 10.

Risk aversion (red line) rose sharply last week while risk tolerance (green line) fell to new lows. The imbalance is now more than two-to-one in favor of risk aversion, meaning that each successive negative news could trigger two sellers for each potential buyer in the market and drive prices sharply lower as sellers rush for the exit. If you are on the buyer’s side, drive a hard bargain, chances are you’ll get the discount you ask for.

European investor sentiment:

European investor sentiment (green line) retraced last week’s sharp drop but remains bearish. The ECB has yet to turn off its supportive monetary policies, providing European investors with some downside risk protection. Chaotic domestic politics in the UK, upcoming presidential elections in France, and uncertainty surrounding the situation in Ukraine, however, is keeping sentiment firmly in the negative for now. Markets have yielded to sentiment in recent weeks but remain far off their September 2021 lows, leaving plenty of downside risk.

Risk aversion (red line) retraced some of its recent gains last week, while risk tolerance (green line) remained mostly flat. This indicates that last week’s rebound in sentiment was mostly driven by investors feeling that things may not be as bad as they previously thought, but certainly not good enough for risk-taking. Any clashes/skirmishes/wranglings on the continent’s eastern front could easily reverse this view.

Global developed markets investors sentiment:

Sentiment among global developed-markets investors (green line) remained bearish last week, virtually unchanged from the previous week. Increasingly negative rhetoric around Ukraine, inflation, and the global supply chain continues to weigh on sentiment. Heavy losses in the US and Europe also led to retreats in global benchmarks. Sentiment among global developed-markets investors has been bearish since early October 2021 now, which by historical standards is a very long stretch. That has kept markets from breaking into new high territory since then, despite two attempts. In the near term, sentiment is too negative to be supportive of a third try. Global investors are likely to take their cues from US investors and the Fed’s next (hawkish) moves.

Risk tolerance (green line) and risk aversion (red line) narrowed the gap between them last week, mostly due to declining risk aversion levels. As we have seen in other markets, even when investors are feeling less risk-averse, they are not yet feeling more risk-tolerant and risk appetite is still driven mostly by changing levels of fear rather than greed.

Asia ex-Japan markets investor sentiment:

Sentiment (green line) among Asia ex-Japan investors bounced off its lows last week but remains bearish. The prospect of higher US interest rates, a stronger USD, and slower global growth is a triple demerit for the region’s markets. Add to this growing credit default concerns from China’s real-estate sector, which were partially allayed last week with the second rate cut by the BoC. Easier credit conditions helped sentiment recover but will not be enough to drive it back into bullish territory until the three negative forces mentioned above are dealt with. Until then, this remains a risk-off market for investors.

Risk tolerance (green line) and risk aversion (red line) followed the same pattern as in other markets, with the bulk of the improvement in the net risk appetite coming from decreasing levels of risk aversion rather than improving levels of risk tolerance. This is likely to remain the case in the short-to medium-term, until more clarity around the strength and viability of the global economic recovery is established. Until then, markets and sentiment will be driven mostly by investors’ increasing or decreasing risk aversion.

Global emerging markets investor sentiment:

Sentiment among global emerging-markets investors (green line) rose last week from bearish back to neutral, although it is still negative. Of all the markets we cover, emerging markets have had the shortest stint in the bearish zone and seem to be recovering faster than developed markets. This could be due to the low valuations in this part of the world, as emerging markets underperformed all of 2021 and are relatively cheap compared with developed markets.

The negative gap between risk aversion (red line) and risk tolerance (green line) narrowed further last week as investors became simultaneously less risk-averse and more risk-tolerant. Net risk appetite is still negative but the imbalance between the potential supply and demand for risk is now not as dangerous as in previous weeks. In this state, a negative overreaction is less likely as sellers and buyers are more evenly matched than in developed markets.