ROOF Highlights — March 8, 2021

Qontigo ROOF™ Score Highlights: Week of March 8, 2021

Potential triggers this week: In the US, passage of the $1.9 trillion package is slated for Tuesday, inflation data on Wednesday, and consumer confidence on Friday. Elsewhere, updated GDP figures for the Eurozone, Japan, and the UK.

Summary: Sentiment continued to decline ending in bearish territory for all major markets except the UK. Markets seem to be responding to the recent lack of risk appetite as they did back in October 2020. Mr. Powell’s impassive assurances that the Fed will maintain its current massive asset purchasing program, gave investors the impression that it wasn’t that he can’t handle the truth about the inflationary pressures these programs have unleashed. He’d just rather not. For the time being, at least. As mentioned over the past few weeks, investor sentiment lost that herd immunity to downside risk it acquired late last year after multiple vaccine news, and now seem more of the mind that overconfidence at these levels could lead to hubristic losses. In that state of mind, confirmation bias makes them more likely to sell on bad news than to buy on good news. Aware of the divergence between markets and sentiment, investors seem to be asking – “If overconfidence is to be continuously rewarded – courtesy of asset purchasing programs – where can I get me some?

Sentiment turns bearish in the US, will markets follow?

The STOXX USA 900 index seems to be worried about the growing lack of risk appetite among US investors which last week turned bearish for the first time since the COVID-19 vaccine news in early November last year (top chart). Both ROOF variants agree on the deteriorating sentiment as they did back in October 2020. The vaccine news on November 11 last year lifted sentiment and markets back from their lows but it is hard to see what news could come this week to affect the same turnaround.

Risk tolerance (green line) is now back to the October 2020 lows, and risk aversion (red line) seems headed for its October highs as well (bottom chart). The supply-demand for risk is now increasingly negative, leaving markets vulnerable to downside over-reaction in the case of negative news which may be triggered by higher inflation numbers as soon as this Wednesday.

European markets remain in denial of a sharply deteriorating investor risk appetite.

Sentiment among European investor has now breached into the bearish zone, deteriorating sharply from the post-vaccine-post-trade deal news of late last year (top chart). Markets, meanwhile, after initially heeding the call from a declining risk appetite, have rebounded last week in defiance of a growing risk aversion level. The growing divergence between market performance and investor sentiment will need to be addressed. Either incredibly good news comes along to lift sentiment or markets correct from their current highs to allow for risk appetite to return based on valuations.

The gap between risk tolerance (green line) and risk aversion (red line) is now larger than it was last November when the vaccine news lifted sentiment. The COVID narrative is headed in the right direction, but remains highly vulnerable to a third wave until the vaccination drive reaches more of the population. Meanwhile, early re-openings or new variants could still lead to a third wave.

Global markets decline with sentiment while Asia ex-Japan remain in denial.

The STOXX Global 1800 declined further last week in line with a rapidly declining investor sentiment. Both ROOF variants have been on a sharp declining path in the last month with the Sector ROOF now in bearish territory (top chart). The last time sentiment fell this low it took multiple vaccine news to raise risk appetite and markets from their lows. Given the still highly uncertain COVID situation near term, it is hard to identify an event that can have that much lifting spirit on sentiment.

Asia ex0Japan paints a mixed picture with markets continuing to rise in the face of declining sentiment (bottom chart). In early February, the Style ROOF ratio was contradicting the Sector ROOF’s bearish mood but recently both seem, to be headed lower with the Sector ROOF now as low as it was in early March during the worst of the COVID crash. Given this divergence, markets are far ahead of sentiment and any negative news can send them into a sharp correction.