ROOF Highlights — July 4, 2022

Qontigo ROOF™ Score Highlights: Week of July 4, 2022

Potential triggers for sentiment this week1 :

  • US: FOMC meeting minutes, jobs report.
  • Europe: BoE’s Bank Financial Stability, ECB’s Lagarde speaks in Aix-en-Provence, France.
  • APAC: China Services PMI, Japan household spending, interest rate decision by the RBA in Australia.
  • Global:
    • On the macro front, changing estimates of the economic costs of defeating inflation.
    • On the geopolitical front, changing estimates of the political costs of defeating Russia in Ukraine.
    • On the sustainability front, the changing estimates of the costs of extreme weather events. 

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 declined across all markets we track last week, ending bearish in the US, global developed markets and Europe. The previously bullish sentiment in global emerging markets and China weakened in the week to be just positive now, and the positive sentiment among Asia ex-Japan and Japan investors turned to negative.
  • The US market, the best performer in 2020 and 2021, has turned bitter from the sweet so far in 2022. It has suffered its worst first half-year performance since 1970. The same holds true for the pandemic’s movers and shakers, which have themselves been severely moved and shaken. Other risky assets, such as cryptocurrencies, seem headed to a place where all sorts of wounded chickens are presently limping home to roost.
  • For the next two weeks (at least), macro and geopolitical news will continue to dominate the front page of major newspapers. Their mostly binary outcomes are ill-suited for most forecasters’ convergent minds, and they require a degree of divergency that analysts are not comfortable with. Lacking confidence in their forecasts, investors cannot objectively disagree with each other and trade, resulting in a market where emotions will ensure that trading remains dangerously subjective.
  • Since the start of 2021, the preferred emotion has been risk-aversion, making risk-tolerance seem so arrière-garde now that it is beginning to look avant-garde. Unfortunately for would-be contrarians, once investors acquire the habit of being risk-averse, it is astonishing how impossible it is to make them give it up without good reasons. This is where the upcoming quarterly earnings reporting season comes in.
  • In two weeks, the microphone will change hands, from central bankers and Presidents, to CEOs and analysts. In theory, the divergence in earnings reports will create greater dispersion between winners and losers, bringing down the currently elevated level of stock correlation and raising the amount of diversification available to investors for risk management.
  • The quo for this huge quid is that management will be prepared to give investors detailed guidance as to their earnings outlook for the rest of 2022 and beyond. If it appears that they, too, lack the visibility and clarity needed to confidently steer their business through these uncertain times, then investors are likely to stay under the risk-aversion security blanket they have been curling under for the past six months.

Jump to a specific market

US investor sentiment

Sentiment among US investors (green line) continued to decline, ending last week bearish in the face of ongoing worries about the probability of a recession as early as this year. Sector allocations (red dotted line), confirms the deterioration in risk appetite, with most investors now implementing a risk-averse strategy instead of a risk-tolerant one previously. On the positive side, this is the third such pivot year-to-date, and each has had a higher peak and a lower trough than the previous one. One the negative side, the Fed will not be coming to investors’ rescue any time soon — in fact it may rapidly increase the alternatives to equity available to investors — and corporate earnings look more uncertain now than they have been for the last decade, making the US stock market the land of the free (-er) and the home of the (truly) brave.

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European investor sentiment

European investors’ sentiment (green line) also declined further, ending the week bearish for the first time since March. Sentiment has been on a downtrend since May, when investors were first told by the ECB that it would not be able to come to their aid until inflation, which they have misjudged, shows concrete signs of receding, even if this results in a recession. The prospect of positive interest rates for the first time since 2016 is also providing European equity investors with an alternative place to beach themselves during the hot summer months. The imbalance between potential sellers and buyers is now back to levels not seen since the start of the year, indicating a growing negative risk appetite and a risk of (downside) overreaction to negative news in the near term.

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Global developed markets investor sentiment

Sentiment among global developed-markets investors (green line) remained bearish last week, dipping below the lows reached in May to levels not seen since March. Sector allocations (red dotted line) also pointed to a rush to implement risk-averse strategies, indicating that higher market volatility alone is not the only factor behind investors’ increased risk aversion. The gap between the potential supply and demand for risk from investors is now sufficiently large and negative to cause an overreaction to negative news and send markets sharply lower, especially given the thin holiday volume. No positive news is expected in the short term, so expectations are already low, but any hints that the macro situation is either worse than previously thought or just deteriorating further, will send investors running for the sidelines. This remains a buyer’s market for now, so ask for discounts and discounts Ye shall get.

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Asia ex-Japan markets investor sentiment

Sentiment among Asia ex-Japan investors (green line) drifted lower for the second week in a row, ending mildly negative for the first time since mid-May. The continued recovery in sentiment that started in mid-March this year provided good support for markets during May and June. Sector allocations (red dotted line) continue to indicate that investors are implementing mostly risk-tolerant strategies, but if sentiment deteriorates further it could lead to the same strategy pivot we saw in developed market during the second half of June. The recovery was driven mostly by a feeling that what is good for China is good for the region, but lately investors are questioning whether a resurgent Chinese economy will be enough to counter the negative impact of both the US and European economies falling into recession. Risk appetite remains neutral for now and should allow markets to remain in a tight range in the near term.

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Global emerging markets investor sentiment

Sentiment among global emerging-markets investors (green line) has lost its bullish feeling but remains positive. The resurgence in sentiment since early May has helped markets stay above their previous lows, but the implementation of risk-tolerant strategies that began in mid-April via sector allocations (red dotted line), has yet to be rewarded with positive market returns. Having held on to risky positions for a month and a half now, without reward, may lead to bullish fatigue for investors during the quiet summer months. Higher market volatility and an unwinding of those risk-tolerant positions could push markets back to test their previous lows. Currently, risk appetite remains positive but has weakened for the past two weeks. If this trend continues, risk appetite will not be positive enough to allow markets to rally without strong positive news on the macro front.

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Japan market investor sentiment

Sentiment among Japanese investors (green line) declined sharply last week, ending negative for the first time since early June. Despite an improving sentiment in May and June, sector allocations (red dotted line) continued to imply that investors were implementing risk-averse strategies and not risk-tolerant ones. The lack of strength in risk appetite has kept markets from breaking on the upside over the last three months. If sentiment continues to deteriorate and becomes bearish again for the first time since February-March this year, markets will lack the support they need to prevent a return to the March lows. For now, risk appetite is neutral, but the momentum seems to be on the side of rising risk-aversion, which could convince nervous investors to cut their losses and head for the exit until the macro picture becomes clearer.

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China (domestic) investor sentiment2

Sentiment (green line) among Chinese (A-shares) investors ended its short foray into the bullish zone, closing the week (only) strongly positive. Chinese investors remain the most positive of all market participants we track. This is not surprising given the local authorities’ rhetoric about reflating the economy. Sector allocations, however, imply that investors have stopped implementing risk-tolerant strategies since late May, and may need to see more details about economic stimulus plans before turning more bullish. Too many open questions remain unanswered with regards to the status of China’s relationship with the West, and the US in particular, for investors to be comfortable — never mind confident — about holding on to risky positions for too long. A positive risk appetite points to the benefit of the doubt being on the side of the authorities, but they will need to deliver some concrete results soon for sentiment to become bullish again and for markets to continue rising.

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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