ROOF Highlights — March 21, 2022

Qontigo ROOF™ Score Highlights: Week of March 21, 2022

Potential triggers for sentiment this week1 :

  • US: Quiet week on the data front with only a few Fed speeches to look out for.
  • Europe: No data but the recent rise in COVID-19 cases will be in focus.
  • APAC: No data this week but news on COVID-19 lockdowns in China will be watched.
  • Globally: The ongoing conflict in Ukraine, and the still fluid COVID-19 situation across Europe and Asia, will continue to dictate investor sentiment.

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 bearish last week across all markets we track, with US investors showing the only signs of a timid recovery. The impotence of western sanctions on Russia continued to weigh on sentiment in Europe, while renewed lockdowns in China raised fresh concerns about the global supply chain, affecting investors in Asia. The rapidly worsening sentiment among emerging-markets investors signals those sanctions are working in all the wrong places.
  • The Russian leadership is now openly targeting both Ukraine’s army and its people. NATO countries, meanwhile, are only targeting the Russian people via economic sanctions, and not the Russian army. It is a bit like threatening someone who holds you up at gun point with a lawsuit on their relatives if they don’t back down. And calling them a criminal isn’t going to work either. We’ve been there and done that countless of times, with an appalling track record.
  • In the face of an increasingly aggressive and expanding war in Ukraine, as well as the ongoing ‘frenemies’ relationship between the US and China, investors have decided that for both geographical and economic reasons, the US market is the safest place to be in the short term. But it will take more than sanctions or tough rhetoric to lift sentiment back into positive territory. It will take results and a credible path towards a lasting peace.
  • Putin mistook Ukraine for 1968 Czechoslovakia, and NATO failed to remember that an autocratic leader is not trained to think of the “we’ but only the “I”. The conflict is at a stalemate for now, but the price of uncertainty will remain high, keeping sentiment under pressure, until both sides stop giving speeches that offend the senses, and find a way out of this collective amnesia.
  • To quote Andy Warhol, people will always prefer to look at something rather than nothing. Amid a lack of company earnings reports, investors will focus on the flashing war headlines on the front page. For sentiment to fully recover, there must be peace. The peace dividend will take care of earnings.
  • Going forward, the key factors that will continue to sway sentiment for the better or worse, will be the war in Ukraine, China’s relationship with the West, and the taming of the inflation shrew, globally. Regrettably, all three are linked to Putin.

US investor sentiment

US investor sentiment (green line) bounced off its recent lows, managing to climb for two consecutive weeks and helping markets erase all their month-to-date losses. The recovery in sentiment was helped by a widely anticipated interest rate hike. Investors had feared, and perhaps priced in, a 50-bps rate hike by the Federal Reserve, and were relieved to see only a 25-bps raise. With this move, the Fed has signaled its twin goals of fighting inflation and fostering maximum employment when thinking about monetary policy change: first, be fairly sure this move will not make things worse; second, be fairly sure this move will make things better. At the leisurely pace of 25-bps, investors seem to agree that both goals can be met. This still leaves the two big unknowns of the ongoing conflict in Ukraine and the disruption caused by new cases of COVID-19 on the global supply chain for investors to worry about. It will take more than incremental gains on these issues to bring investor sentiment back to positive. The US market, however, may continue to recover on its safe-haven status alone in the short term, giving investors one less reason to remain bearish.

Risk aversion (red line) and risk tolerance (green line) converged slightly in the past two weeks but remain far apart, with potential sellers still outnumbering potential buyers by more than two-to-one. Despite this slight recovery, risk appetite remains more negative than it was in all of 2021. Not even the recent decline in market volatility or the resolution to the interest-rate question seem to have been enough to raise risk tolerance back to even its January levels. Downside risk protection remains the consensus view, with a focus on upside potential being the purview of the contrarian.

European investor sentiment

European investors’ sentiment (green line) remained bearish last week, ending virtually unchanged from where it has been for the past two months. The more risk-tolerant sector allocations, which coincided with the start of negotiations between the Ukrainian and Russian leaderships earlier this month, reversed last week on the lack of progress and an escalation of hostilities towards the civilian population in Ukraine (red dotted line). Russian missile strikes in western Ukraine, near the Polish border, has also unnerved investors and raised the possibilities of a widening European conflict. This has led to a de-risking of European portfolios as investors temporarily rotate their international funds back to the safety of the US market.

Both risk-aversion (red line) and risk tolerance (green line) experienced a rebound in the last two weeks, but while risk tolerance is just bouncing off its 52-week low, the rise in risk aversion has kept its medium-term uptrend, started in September last year, intact, and may be signaling an attempt at new highs soon. Much will depend on the developments in the Russia-Ukraine conflict. In the short-term, the negative risk appetite means that investors will more likely overreact to negative developments and underreact to positive ones, unless the latter is moving us meaningfully towards peace.

Global developed markets investors sentiment

The recent improvement in sentiment among global developed-markets investors (green line) flattened out last week just inside the neutral zone. The recent improvement in sentiment among global developed-markets investors (green line) faltered last week, ending bearish for the first time this month. The rise in sentiment begun with signs that after a period of confrontation, the time had come for negotiation. Last week’s widening conflict ended those hopes. Risk-taking will not return until clarity emerges on how this conflict will end, and when.

Risk tolerance (green line) remains under pressure, while risk aversion (red line) surged last week after multiple failed negotiations and the conflict spread westward towards Poland. Global markets depend on global trade, which in turn depends on global peace. Until a clear path to a Russian-Ukraine accord or conflict resolution is reached, risk aversion will continue to dominate risk tolerance.  

Asia ex-Japan markets investor sentiment

Investor sentiment (green line) in Asia ex-Japan deteriorated further last week on continued disruptions to the global supply chain from both conflict-based sanctions and renewed lockdowns in key China cities. The decline in sentiment in Asia ex-Japan, Japan and China, also reflects low expectations from the outcome of the Biden-Xi conversation that took place on Friday after Asian markets closed for the day. The US-China relationship has affected regional investor sentiment since 2018 and will continue to be a key factor behind risk appetite in the region. Asian markets have strongly underperformed their developed Western counterparts since the start of the US-China trade war, indicating that mending this relationship is a requirement for investors in the medium-term.

Risk tolerance (green line) declined further last week while risk aversion (red line) edged higher on a combination of local lockdowns and unresolved geopolitical questions as to the status of the US-China relationship. Investors have known that this relationship would define the next decades but were willing to live with frenemies as the ongoing status, where the US and China continue to disagree on global politics but agree on global economics. While this is still the most likely scenario, Russia’s invasion of Ukraine is straining this relationship, testing both sides’ resolve to maintain this delicate contradiction.

Global emerging markets investor sentiment

Sentiment among global emerging-markets investors (green line) took another dive, ending last week deeply bearish. The inflationary impact of commodity prices from the conflict in Ukraine and its related sanctions is putting emerging economies under severe strain. Borrowers in these countries face a triple demerit situation with rising US interest rates, a stronger USD, and higher commodity prices eating into their bottom line. Emerging-markets investors were the last to become bearish, but have now become the most bearish across all markets we track. Given this, emerging markets are more likely to be followers than leaders when a recovery comes.

The gap between risk aversion (red line) and risk tolerance (green line) widened last week, with the former rising sharply on the back of accelerating inflation and commodity prices. Risk appetite remains too negative for a rally to be sustainable, and investors will continue to act more on negative news than on positive ones in the short term. At this level, it will take a sequence of good news to revert the net risk appetite to a positive level for emerging markets.