ROOF Highlights — June 6, 2022

Qontigo ROOF™ Score Highlights: Week of June 6, 2022

Potential triggers for sentiment this week1 :

  • US: CPI, trade balance data, and consumer sentiment survey.
  • Europe: ECB monetary policy meeting; German industrial production data.
  • APAC: Interest rates decision by the central banks of Australia and India. In China, external trade, consumer and producer inflation, and services sector PMI data.
  • Global: Daily news flow out of Ukraine, geopolitics in the South Pacific, extreme weather events, and the debate around the US Constitution Second Amendment

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 ended the week bearish in the US and in global developed markets. It declined to a more negative mood in developed Europe, but just short of a bear level. Sentiment continued to improve, meanwhile, in Asia ex-Japan, global emerging markets and China on the back of the latter’s economic stimulus plans. In Japan, the recovery in sentiment that stalled the previous week weakened further but still ended the week positive, for now.
  • Interrupted only by news of mass shootings in the US, the war in Ukraine continues to dominate the headlines and act as a drag on investor sentiment. Hopes for a de-escalation to a localized conflict in the east and south-east of the country helped sentiment and markets recover in April and early May. Those hopes have now completely receded with threats over the weekend by President Putin of an escalation to new theaters of war not yet active as retaliation for the US sending long-range missile defense systems to Ukraine.
  • US investors head into the summer months in a bearish mood, weighed by ongoing worries about the negative impact of inflation and higher interest rates on corporate earnings and the economy. Additionally, extreme weather events, the constitutional debate on Roe v. Wade, and calls to repeal the US Second Amendment that protects gun ownership, will add to the nation’s already high Gross Divisiveness Product2 (GDP), potentially leading to social unrest and giving investors another reason to remain risk-averse or stay on the sidelines for now.
  • European investor sentiment has steadily declined from the more optimistic levels reached at the end of April, as they begin to incorporate the impact of a hawkish ECB in their forecasts. Regional economies face the most direct impact from the effect of the war in Ukraine via self-imposed sanctions on Russian oil and gas imports, and higher (or even just positive) interest rates may be more than the economic recovery can bear.
  • Sentiment in emerging markets and Asia ex-Japan continue to benefit from the combination of low valuations and hopes for big stimulus packages out of China as the country’s regulators scramble to stop their economy from stalling after months-long lockdowns. The recovery in sentiment in Japan, which started with the country’s reopening in April, failed to reach bullish levels in May and seems to be running out of steam ahead of the summer

2 A term first coined by Joseph Epstein in 2019

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US investor sentiment

US investor sentiment (green line) improved marginally last week, still ending bearish but not as much as in the previous week. Better corporate results battled with a mixed economic report card during the week to keep sentiment in a tight range. Sector allocation decisions (red dotted line) reflect a less negative outlook than in May, but investors remain only cautiously optimistic about the strength of consumer spending. Risk aversion, which declined in the previous week, lingered at elevated levels last week compared to April’s less pessimistic mood. Risk tolerance, meanwhile, was not able to add much to the previous week’s rebound and remains well below its April highs. The large imbalance between the two translates into a still very negative risk appetite for investors, who will continue to overreact to bad news and underreact to good news in the short term.

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European investor sentiment

European investors’ sentiment (green line) declined further last week, ending negative but not yet bearish. Hopes for an early resolution to the war in Ukraine and a still accommodative ECB, led to improving sentiment and the implementation of more risk-tolerant sector allocations (red dotted line) in April. Those hopes were dashed in May. Greater inflation pressures have forced the ECB to communicate the need to adopt a more hawkish stance, leading to a reversal in sentiment and a rotation out of risk-tolerant sectors into risk-averse ones. Risk aversion levels have steadily risen since early May, and while risk tolerance levels remain higher than they have been since October 2021, they began to weaken last week and may not be able to hold on to current levels absent any positive news on the geopolitical or macroeconomic fronts.

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Global developed markets investor sentiment

Sentiment among global developed-markets investors (green line) continued to decline last week, ending bearish for the fourth consecutive week. No region seems to be able to attract a sustainable level of risk tolerance, leaving investors no choice for the time being but to implement a risk-averse strategy aimed at protecting the downside. Risk aversion has been the main driver of risk appetite year-to-date, rising and falling at a faster pace than risk tolerance in each cycle, indicating that even rising markets are being powered by demand for risk-averse sectors rather than risk-tolerant ones. Given the negative balance between the supply and demand for risk assets currently in the market, it is unlikely that any rally will be sustainable without a turnaround in sentiment.

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Asia ex-Japan markets investor sentiment

Sentiment among Asia ex-Japan investors (green line) was mostly flat last week, remaining slightly positive but stopping shy of its highs reached last April. Low valuations for risk-tolerant assets after a prolonged underperformance is attracting bargain-hunting by more risk-tolerant investors. However, we continue to see strong demand for risk-averse sectors, indicating that most investors continue to implement a defensive strategy. This despite risk-tolerance reaching its highest level since early November 2021.

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Global emerging markets investor sentiment

Sentiment among global emerging-markets investors (green line) remained on an upward trend last week, ending strongly positive after having spent one day in bullish territory. This is a familiar pattern we have seen already twice this year where global funds flow rotate into emerging markets when developed ones are down. When sentiment becomes negative in major developed markets, like it did in January and last month in May, it begins to rise in emerging markets. Conversely, once sentiment recovers in developed markets, like it did last April, sentiment declines in emerging markets. Risk tolerance ended last week at the highest level since November 2021, but risk aversion remains higher than its April 2022 or November 2021 lows, suggesting a lack of confidence in this newfound risk tolerance. Emerging markets are up more than 5% on this resurgence of risk appetite, mostly on the back of positive news out of China and the removal of Russia from the investment universe. The global macro situation, however, remains broadly negative for emerging markets and sentiment is unlikely to become bullish until this changes, giving any market rally only short-term support.

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Japan market investor sentiment

Sentiment among Japanese investors (green line) declined last week, ending only slightly positive, after failing several attempts to become bullish during the previous month. The surge in sentiment that started in early April follows a now-familiar pattern of recovery once authorities announce the relaxation of stringent social distancing measures aimed at stopping COVID-19 infections. This resurgence will quickly fizzle out in the face of negative geopolitical and macroeconomic news, which continue to prevent a return to a bullish sentiment. The only positive macro factor keeping sentiment positive for the time being is the resurging US dollar, which hit a new year-high above 130 against the Japanese Yen, helping to lift shares of technology companies and other exporters.

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China (domestic) investor sentiment3

Sentiment (green line) among Chinese (A-shares) investors continued to rise last week, ending strongly positive and just shy of bullish. The main driver continues to be regulators’ supportive comments and announcements of plans to get the economy back on a growth trajectory. Prolonged lockdowns have brought both industrial production and exports to a standstill, and have stifled the consumptions of services in urban areas. The strong recovery in sentiment sparked a rotation out of risk-averse sectors and into risk-tolerant ones as investors switch to implementing bullish strategies, taking advantage of the sharp discount among risky assets after nearly five months of declining market prices. The demand for risky assets is now stronger than the supply for the first time since November last year, indicative of an increasingly positive risk appetite among investors. Markets have responded in kind, rising almost 10% since the mid-April lows. Going forward, authorities will have to deliver on those stimulus promises for local sentiment not to succumb to global risk-aversion.

3 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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