ROOF Highlights — July 25, 2022

Qontigo ROOF™ Score Highlights: Week of July 25, 2022

Potential triggers for sentiment this week1 :

  • US: FOMC meeting: the Fed is expected to raise interest rates by another 75 bps. More than a third of S&P 500 companies report earnings this week, including four of the FAANGs (Apple, Amazon, Google’s parent Alphabet, Meta Platforms), as well as Microsoft, 3M, Ford, Boeing, and Intel.
  • Europe: Germany, France, Italy, and Spain will publish key reports on growth and inflation rates. The Eurozone growth is forecasted to be an anemic 0.1% in Q2, and inflation to rise further to 8.7% in July. German consumer sentiment is expected to hit a record low in July. Germany, France, and Spain will also release jobs data.
  • APAC: Japan is set to release a slew of data including June unemployment, retail sales and industrial output, and July’s consumer sentiment. Australia will report inflation data for Q2.
  • Global: Corporate earnings and monetary policies have displaced the war in Ukraine as the most influential factors in the short term.

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:

  • Sentiment continued to recover in all markets we track as the Q2 earnings reporting season is having a positive impact on investors’ mood. The better-than-feared (so far) reports and guidance is lifting sentiment away from fears of a deep recession and towards hope for a mild and short one that could spare corporate profits.
  • Sentiment seems to have hit a hard (bearish) bottom in Q1, followed by another two lows in Q2, each higher than the previous one. Investors appear ready to try and become less fearful, and more hopeful, than they have been at any other point this year. Note, however, that nothing is more precarious than relying on the sentiment of a summer investor, that temporary class which is also easily the most unreliable ethnic group. 
  • While sentiment implies transience, it should never be thought of as trivial. At its extremes, sentiment speaks to the opposite human impulses of fear and greed. As a group, investors have never been credited with ‘independence of mind’ or ‘courageousness of thought’. The recent recovery has simply brought us back to a ‘safe’ level where decision-making becomes more rational and lacks the potential for extreme emotional reaction — in either direction — to news flow.
  • This reprieve from a possible investor tantrum is brought to you by corporate CEOs and their investor relations departments, who have the microphone for just another three weeks. Their spin is being heard over the geopolitical background noise of the ongoing war in Ukraine and its impact on monetary policy and economic growth, and the climate change clamor of extreme weather events. What happens after CEOs stop talking?
  • Domestic politics is not helping either. With France’s Macron yielding his legislative majority, Britain’s Johnson losing his post as Prime Minister, Italy’s Draghi resigning his, and the US’ Biden becoming increasingly unpopular at home, the Western coalition against Putin is starting to look a bit rudderless. Leaders worthy of voters’ admiration and loyalty do not come cheap, and the Western world may have run out of them at just the wrong time for investors. 

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US investor sentiment

Sentiment among US investors (green line) continued to recover last week, ending perfectly neutral (ROOF Ratio = 0.01). The recovery to a new year-to-date high (hard to believe sentiment has never been positive yet this year!), seems to confirm a medium-term bottoming out of a bearish cycle that begun in December 2021. The timid recovery, tested twice in Q2, has gained momentum with the current earnings reporting season that has, so far, been better than feared. As a result, the de-risking of portfolios that began in December 2021 based on inflation fears, and continued in Q1 2022 on the basis of worst-case (deep) recession fears, is being slowly unwound as consensus migrates towards a base-case scenario of a mild recession. However, sentiment is not yet positive, and investors cannot be called cautiously optimistic at this time — they are simply hopeful that the future isn’t as bleak as they previously thought. For now, risk aversion and risk tolerance are evenly matched, removing the potential for overreaction that a large imbalance between the two can bring. The geopolitical and environmental context for 2022 remains negative, so it will take more than a few ‘not-as-bad’ reports to convince investors they can become positive again.

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European investor sentiment

European investors’ sentiment (green line) continued to recover strongly, ending the week almost at a new year-to-date high. The pattern is like that of the US market, with sentiment having bottomed around March and seeing its low retested in Q2 before the current recovery. Both sentiment and sector allocations (red dotted line) now point to a growing cautious optimism on the part of investors, despite a worsening of the domestic political situation in France, Great Britain, and Italy; as well as the ongoing war in Ukraine, now understood to be expanding from the eastern front to the south of the country. The ECB has raised interest rates to a positive level for the first time since 2014, as well as lowered its estimate of the bloc’s economic growth for this and next year. Yet, investors’ risk-aversion levels continued to decline last week as risk-tolerance rose, which helped markets establish a bottom and stage the start of a recovery. Still, the recovery in sentiment is mostly linked to the fact that the ECB raised rates by less than feared, revised economic growth down by less than expected, and Russia restored the flow of natural gas through the Nord Stream 1 pipeline to the levels it was before shutting it down for maintenance two weeks ago. Markets will need more than the avoidance of a worst-case scenario to sustain their recovery and erase year-to-date losses. As such, ‘hope’ is the best descriptor for the current rally. Fingers crossed.

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Global developed markets investor sentiment

Sentiment among global developed-markets investors (green line) benefitted from the recovery across constituent markets and rose sharply, ending the week in positive territory and at fresh new highs for the year. The recovery that begun in late June has also been stronger and faster here than in the US or Europe, turning sentiment among global developed-markets investors into the most positive of all developed single-currency markets after having been the most negative at the start of the year. This is a recovery that is now six months in the making, and marks the first time since June 2021 where risk aversion has been lower than risk tolerance in this market. A good omen indeed, but can currency volatility, which increases risk for multi-currency investors, stay low long enough to sustain risk-tolerance going forward?

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Asia ex-Japan markets investor sentiment

Sentiment among Asia ex-Japan investors (green line) halted its decline last week, ending still negative but no longer bearish. This mild rebound has kept intact the overall sentiment recovery that began in late March, after sentiment hit its most bearish level. As in other markets, the recovery has been tested twice in Q2 with short dips back into bearish territory in late May and early July, but each low was higher than the March one, keeping the upward trend intact for now. In addition to global monetary policy and economic growth concerns, sentiment in the region is also affected by fears that a resurgence in COVID-19 infections could trigger a return of safe distancing measures in key markets. For this reason, risk aversion remains measurably above risk tolerance in the region and any talks of new lockdowns could rapidly tip the balance in favor of sellers once again.

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Global emerging markets investor sentiment

Sentiment among global emerging-markets investors (green line) ended neutral, and flat from the previous week. As with other markets, sentiment is showing a medium-term recovery pattern with a low reached in late March and two further dips since then, one in May and one in July, but both higher than the prior one. This positive momentum in sentiment has helped put a floor on markets since May but any rebound will not be sustainable until sentiment clears the bullish level (ROOF Ratio > +0.5) for a prolonged period. The fundamentals of higher US interest rates and slowing global economic growth will also mean that commodity prices will come under pressure from profit-taking, which could drag down those markets that have benefitted from rising prices until now. Risk aversion and risk tolerance are evenly matched right now, with a slight momentum advantage for risk aversion this month, and should translate into a sideways market in the short term.

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Japan market investor sentiment

Sentiment among Japanese investors (green line) rebounded last week, ending neutral and higher than its bearish finish of the previous week. This is the only market where the recovery trend seems in doubt. Sentiment among Japanese investors bottomed out in March, in sync with other markets, then experienced a strong recovery fueled by the rapidly weakening Japanese Yen and the reopening of the economy following COVID-19-related restrictions. Optimism from a weaker currency, however, soon gave way to concerns that rising inflation could hurt the domestic consumer, on whom the economy relies on for 60% of its growth. The central bank has so far ignored this danger and maintained its QE program, thereby providing a floor for markets in the short term through its asset -purchasing program. A sustained recovery in sentiment, and markets, however, requires alignment between the country’s consumer and policymakers. For now, the two remain at odds, which could prevent sentiment from becoming bullish and supportive of  markets through rising risk tolerance — a requirement for a sustainable rally.

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China (domestic) investor sentiment2

Sentiment (green line) among Chinese (A-shares) investors weakened slightly in the past two weeks but ended still positive, keeping alive the medium-term recovery pattern we have seen here and in other major markets. Sentiment in China bottomed out in January, slightly sooner than in other markets. A failed recovery attempt in February and March led to another test of the emotional lows in April. Sentiment then managed to rebound again before dropping below its January lows, and staged a strong and steady recovery to become bullish by mid-June, thanks to the reopening of major cities after a two-months lockdown. Since then, investors have found little to become more bullish about and sentiment has drifted back into neutral, albeit still positive. Risk aversion has remained below risk tolerance since Mid-May, but the gap between the two has been narrowing in the past three weeks. Sector allocations (red dotted line), meanwhile, reflect a slightly more cautious outlook in the short term. Conclusion: the market lacks emotional direction right now.

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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