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ROOF Highlights — July 31, 2023

Qontigo ROOF™ Score Highlights: Week of July 31, 2023

Please note that the ROOF Highlights will be taking a short break over the next fortnight, returning on August 21. If you do not currently subscribe, please click here to have these reports and more, delivered directly to your inbox.

Potential triggers for sentiment-driven market moves this week1:

  • US: Earnings reports from Apple Inc, Amazon.com, Advanced Micro Devices, Shopify, Alibaba Group, Uber Technologies, Merck & Co, Pfizer, Gilead Sciences, Moderna, Caterpillar Inc, Starbucks Corp, The Kraft Heinz Co, Etsy, PayPal Holdings, and Airbnb. On the macro side, Manufacturing and Services PMI and the Jobs report.
  • Europe: Bank of England interest rate decision (+0.25% expected), and flash estimates for the second-quarter GDP and inflation for the Eurozone.
  • APAC: China PMI data, minutes of the BOJ meeting in Japan, and the RBA rate decision in Australia.
  • Global: Corporate earnings results and the picture they will paint of the strength of consumer spending, rising energy (oil) prices, and detailed minutes of the most recent central bank rate decision meetings.

Insights from last week’s changes in investor sentiment:

Investor sentiment has bottomed out in every market we follow, except in China where investors remain unconvinced for now by the latest stimulus measures announced by the authorities, and in the UK where sentiment continues to decline, threatening to turn bearish this week, ahead of the Bank of England interest rate decision on Thursday. Investors also remain in a bearish mood in three markets; global developed, global developed ex-US, and  Europe. We also note that several markets (global developed, global developed ex-US, Europe, UK, and US) are defying sentiment by rising as investors turned more negative. This implies that the latest rallies in these markets were being driven by increased demand for risk-averse assets, instead of a newfound willingness to speculate on riskier assets.

Year-to-date, the Bulls have been rewarded for waging a constant war against any Bear who seemed to be on the wrong side of the economic debate, which may itself just have been reframed (soft landing or no landing) and the potential answers to which have only just been altered (a hard landing is no longer an option). Bears, for their part, assert that expecting to avoid a recession after consecutive hikes have raised interest rates to their highest level in 22-years (in both the US and Europe), is making demands on the economy that are impossible and towards ends that are unachievable. The fact that the economy has not yet fallen into recession, they claim, is not evidence that it never will.

Last week, in a widely expected move, both the Fed and the ECB raised borrowing costs for the 11th and ninth consecutive time, respectively (both the BoE and the RBA are expected to follow-suit with raises of their own this week). A benign reading of their press releases could view this as an admission that both central banks are now all but done with interest rate hikes. But whatever else they are known for, investors have never been known for reading things in a benign way.

For over 16 months now, major central banks, except for the Bank of Japan and the Bank of China, have attempted to rein-in the highest inflation rates in decades, by slowing their economy down. The issue for investors now is that economic data is built on a retrospective approach, analyzing the impact of past decisions and events to understand what has already occurred. Investing, meanwhile, relies on a forward-looking approach, anticipating future possibilities and making predictions to guide decision-making. To use a driving metaphor, the economy is the rearview mirror, while anticipating what comes after the curve on the road ahead is the main concern (for the investor). The current cautious sentiment reflects the disagreement that exists between those two views; the straight-line investors are forecasting, and the winding mountain road the mirrors are reflecting .

Bulls point to the low volatility readings as a further sign that markets are headed for a straight line. Bears counter that low volatility readings tend to conceal warning signs, which go off earlier when volatility is high. In short, the debate centers on whether low volatility reflects confidence in what comes next, or have investors simply become, to quote Pink Floyd, “comfortably numb“?


Note: green background = bullish, red background = bearish

Changes to investor sentiment over the past 180 days for the markets we follow:

How to read these charts: The top charts show the ROOF ratio (investor sentiment) in green (left axis), against the cumulative returns of the underlying market in black (right axis). The horizontal red line at -0.5 (left axis) represents the frontier between a negative sentiment (-0.2 to -0.5) and a bearish one (<-0.5), and the horizontal blue line at +0.5 (left axis) represents the frontier between a positive sentiment (+0.2 to +0.5) and a bullish one (>+0.5). Around the horizontal grey line at 0.0 (left axis), sentiment can be considered neutral (-0.2 to +0.2).

The bottom charts show the levels of both risk tolerance (green line) and risk aversion (red line) in the market. These represent investors’ demand and supply for risk. When risk tolerance (green line) is higher than risk aversion (red line), there are more investors looking to buy risk assets then investors willing to sell them (at the current price), forcing risk-tolerant investors to offer a premium to entice more risk-averse counterparts to take the other side of their trade, which drives markets up. The reverse is true when risk aversion (red line) is higher than risk tolerance (green line). The net balance between risk tolerance and risk aversion levels is used to compute the ROOF ratio in the top charts, representing the sentiment of the average investor in the market.

The blue shaded zone between levels 3-4 for both indicators, represents a reasonable balance between the supply and demand for risk in the market. Conversely, when both lines are outside of this blue zone, the large imbalance in the demand and supply for risk can lead to an overreaction to unexpected news or risk events.

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Asia ex-Japan:

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Australia:

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China:

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Developed markets:

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Developed markets ex-US:

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Emerging markets:

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Europe:

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Japan:

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UK:

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US:

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

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