ROOF Highlights — May 23, 2022

Qontigo ROOF™ Score Highlights: Week of May 23, 2022

Potential triggers for sentiment this week1 :

  • US: more earnings from major retailers (Best Buy, Costco, Macy’s and Nordstrom), along with personal spending and income data, and the Fed’s May meeting minutes.
  • Europe: flash PMI data for the Eurozone, UK, Germany and France.
  • APAC: Japan PMI and Tokyo CPI data. China will report industrial profits for the first four months of the year as well as any new development regarding the reopening timeline of major cities after the recent COVID-19 lockdowns.
  • Global: the war in Ukraine will continue to weigh on investor sentiment, making global economic forecasts unreliable and keeping markets volatile.

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:

  • Last month’s recovery in sentiment was sent into reverse in May with investors in the US, developed world and Asia ex-Japan ending last week bearish. Sentiment also weakened in developed Europe, ending in negative levels but not yet bearish. Investors in emerging markets, Japan and China ended the week neutral.
  • In April, sentiment recovered from its bearish lows reached in March, ending the month at a more hopeful but not yet bullish level. The brainstorming behind this recovery was that Russia’s invasion of Ukraine had failed, inflation had peaked, and markets had priced in too many future interest-rate hikes. Recent events have led investors to realize that perhaps they had put “the Descartes before the horse.”
  • The war in Ukraine remains the primary driver of investor uncertainty and market volatility, and adds to concerns about higher inflation, tighter monetary policies and a rising probability of stagflation in major economies. Until investors can confidently forecast when and how this war will end, risk aversion will remain the favorite strategy with investors.
  • The intervention in Ukraine was all means and no end from the start. In Putin’s world, you are either anvil or hammer, and there is no place for compromise or conciliation. Faced with the probability of losing this war, he seems to have pivoted to a scorched-earth strategy in Ukraine. The ramifications of which, on commodities markets, is yet unknown but could be long-lasting.
  • The loss of Ukrainian commodities and the halt of Russian oil exports to major European countries will continue to cloud global economic growth forecasts well into 2023 and remain a major source of market volatility. The lesson from April is that second-guessing Putin’s plans comes with a warning label for investors.

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US investor sentiment

US investor sentiment (green line) has become even more bearish in the past two weeks, on a combination of increased geopolitical risk from the war in Ukraine as well as the first signs from corporate America that prolonged inflation is starting to impact profit margins. Previously, only the tech sector seemed at risk from higher interest rates and rising inflation, but earnings reports from retail giants last week confirmed investors’ fears that higher consumer prices have already started to dent profitability. Given the bearish sentiment, this negative news caused an overreaction on the downside (e.g., Target shares fell by 26% in a single day). Risk aversion has risen sharply in the past two weeks and is likely to remain well above risk-tolerance levels in the short term.

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European investor sentiment

European investors’ sentiment (green line) declined in the past two weeks, ending negative but not yet bearish. The war in Eastern Europe and the escalation of tensions between Russia and the international community halted the recovery in sentiment, sending it back down into negative drive. The odds of a victory for Putin are getting smaller each week, and the post-war geopolitical isolation of Russia, with the formal application by Finland and Sweden to join NATO, looks to be even worse than before the invasion. Staring at the face of failure on every front, Putin seems to have opted to simply cause as much damage to the Ukrainian economy and infrastructure as possible, leaving nothing standing in his wake. Investors are now incorporating the large rebuilding costs as well as the investment needs for western Europe to move away from its dependence on Russian oil and gas into their forecasts. Consensus for now is that this war is far from over, but also that it will change the balance of power in Europe and globally. No one wants to say they want regime change in Russia but nothing short of that will ensure a lasting peace for Europe. Uncertainty and volatility will remain high until this conflict ends and the true extent of the damage can be estimated. For now, more and more economists are raising the probability of stagflation for Europe within 2022.

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Global developed markets investor sentiment

Sentiment among global developed-markets investors (green line) declined in the past two weeks, ending bearish, as hopes for an early end to the war in Ukraine were met instead with an escalation of tensions between Russia and NATO. This turnaround in sentiment marks the second time this year and the fourth time since September 2021 that investors have their hopes for either macroeconomic or geopolitical improvement dashed by the realities on the ground. Of the three issues pressuring sentiment — the war in Ukraine, rising inflation, and COVID-19 lockdowns — the latter is the most likely to see some relief soon, but that may not be enough to allow sentiment to rise past recent peaks. Instead, we are likely to keep seeing this sentiment rollercoaster continue as investors’ mood swings between bearish and neutral over the summer. Given this fragile situation, any additional negative news (e.g., political, health scare, weather-related, etc.), could send investors running for the exit. The current mood is that the situation is negative, but not yet hopeless.

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Asia ex-Japan markets investor sentiment

Sentiment among Asia ex-Japan investors (green line) followed other markets down in the past two weeks, ending the recovery started in late March and finishing bearish for the first time since early April. Sentiment was brought down in May by the prolonged COVID-19 lockdowns in China and Hong Kong, but investors are now seeing signs that these may soon be lifted, helping risk tolerance to rise last week for the first time this month. Negative pressures in the form of a sharply stronger US dollar, higher US interest rates, and slowing Chinese and global economies, remain in place for the region and are likely to cap any recovery in sentiment in the short term. Only the end of the war in Ukraine can give investors hope that these pressures will reverse, and allow sentiment to return to a bullish mood. The odds of this seem low for the time being.

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Global emerging markets investor sentiment

Sentiment among global emerging-markets investors (green line) rebounded last week, ending neutral, and narrowly avoiding becoming bearish for the time being. Continued verbal support from Chinese regulators for their economy, as well as prospects of an end to the COVID-19 lockdowns at the end of the month, helped sentiment halt its month-long decline. Talk of support has helped, but more policy specifics as well as a stronger monetary stimulus will be required for sentiment to recover further in the short term. Emerging economies are facing strong headwinds from rising costs and lower demand, but may also soon face weather-related crises as well as food shortages, both of which will further weigh on investor sentiment ahead of the summer months. Rising US interest rates is also diverting assets away from riskier emerging markets into the safety of US treasuries. At this point it seems emerging markets have simply become unattractive, but not yet dangerous.

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Japan market investor sentiment

Sentiment among Japanese investors (green line) ended the week flat, just below the bullish level, where it has been since the start of May. The rise in sentiment during the month of April was spurred by the sharply weaker yen and the absence of strong inflationary pressures, keeping the BOJ’s current easy monetary policy in place. Going forward, Japan may not be able to escape the rising inflationary whirlwind and the month-long rise in risk tolerance may go into reverse. Also last week, Japanese Prime Minister Fumio Kishida gave strong indications that the country’s notorious pacifist stance may have ended after Russia’s invasion of Ukraine. A more assertive Japan on the world stage, especially in Asia Pacific, is likely to be seen by China as a threat and a further effort by the West to contain it, leading to renewed tensions between the two nations going forward. This would be yet another unintended consequence of Russia’s military gamble, which neither President Putin nor President Xi would have expected. Investors will need some time to digest the implications of this geopolitical change if it is to become permanent. Rising sentiment in April proved not enough to drive markets higher. If sentiment were to go into reverse, it would add to pressures on markets and drive prices down to test new lows.

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China (domestic) investor sentiment

Sentiment (green line) among Chinese (A-shares) investors rose last week, ending in positive territory but not yet bullish, on the back of further monetary easing by the BoC. Both a liquidity injection by the central bank and prospects of an end to the COVID-19 lockdowns at the end of the month helped sentiment recover. The Chinese market has been an underperformer this year and the economic damage from prolonged lockdowns means further downgrades will have to be made to earnings forecasts in the near term. This will keep markets in a tight range until the full extent of the damage can be estimated. Also on investors’ risk radar is the strength of the US dollar versus the renminbi and this will constrain the BOC’s appetite for strong monetary stimulus — the missteps of August 2015 still being very much on investors’ mind. If a slow return to normal and a weak monetary stimulus are the only positives in the near term, they are unlikely to be enough for either sentiment or markets to stage a sustainable recovery. There is just too much fragility on too many fronts for sentiment to be able to lead markets out of their current downtrend for long.

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