ROOF Highlights — May 3, 2022

Qontigo ROOF™ Score Highlights: Week of May 3, 2022

Potential triggers for sentiment this week1 :

  • US: Busy week in the US with the Federal Reserve expected to raise interest rates by 50 bps on Wednesday, the jobs report on Friday, and more Q1 2022 earnings releases.
  • Europe: The Bank of England (BoE) is expected to raise interest rates by 25 bps for the fourth straight time. Also out is the Eurozone’s PPI data.
  • APAC: Inflation data from several countries. Q1 2022 earnings from Alibaba and PetroChina on Friday. Also weighing on sentiment are news of further lockdowns across major cities in China.
  • Global: The war in Ukraine will continue to dominate headlines. As Western allies increase pressure on Vladimir Putin, investors will focus on any further Russian retaliatory actions.

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:

  • The recovery in investor sentiment which began in late March in most markets except China, peaked and started to reverse last week, ending lower in all markets except Japan. Investors are once again becoming more negative but are not yet bearish. Japanese investors remained positive, driven by the sharply weaker JPY, but failed to become bullish last week, with sentiment ending off its highs.
  • A combination of factors has driven sentiment lower, including the prospect of faster interest rate increases in the US, higher market volatility, the first batch of negative earnings surprise in the US since Q2 2020, a worsening stand-off between Russia and Western allies in Ukraine, and an expansion of lockdowns in China.
  • If the trifecta of weaker economic growth, lower corporate earnings and higher inflation becomes the consensus, sentiment will continue to suffer until it once again becomes bearish. At that point, investors will be more prone to overreact to negative news, and markets will test new lows.
  • Conversely, any positive news on those three macro fronts, or a credible prospect of an end to the war in Ukraine, will lift sentiment and markets as investors turn bullish and start to overreact to positive news and underreact to negative news.
  • Investing is forecasting, but this simple truth is made increasingly harder by ongoing challenges surrounding the situation in Ukraine, China and the desynchronization of monetary policies across major central banks. Simply put, it’s raining uncertainty everywhere right now and investors are taking cover.
  • Given this negative risk appetite, we expect risk-averse assets to remain more popular than risk-tolerant ones in the near term, as investors focus on protecting the downside.

US investor sentiment

US investor sentiment (green line) made a U-turn last week, capping a month-long recovery and ending the week almost bearish. The combination of rising market risk and a less-than-positive earnings season has led many to start once again implementing risk-averse strategies in their sector allocation (red dotted line). Investors have lost the confidence in their original earnings forecasts, and are now focused on the potential downside risk to the economy from rising interest rates, inflation, the war in Ukraine and supply-chain disruptions form the lockdowns in China. This was evident in the sharp rise in risk aversion last week, coupled with a decline in risk tolerance, indicating that investors are back to favoring a risk-averse assets over risk-tolerance ones.

European investor sentiment

European investors’ sentiment (green line) peaked mid-week and ended slightly lower as investors digested the latest challenges to the global economy. The increasing risk of cuts in natural gas supply to key economies of Western Europe from Russia also weighed on sentiment. European investors have implemented risk-tolerant sector-allocation strategies for the past four weeks (red dotted line). For this to change, they will need assurance that the situation in Ukraine will not spill over onto major economies in the form of higher commodities prices, as Russia retaliates against the Western alliance. At this point in the conflict, this may be a big ask. The situation remains highly volatile and unpredictable. Given this, positive sentiment is likely to have peaked for now until more clarity is delivered.

Global developed markets investors sentiment

Sentiment among global developed-markets investors (green line) ended nearly flat last week, failing to build on its recent recovery. As in most developed markets except Japan, rising uncertainty has meant that sentiment is not likely to improve further and is more likely to take its cues form negative news rather than positive ones. The threats to global growth remain too numerous and real to be ignored, and investors will return to their risk-aversion playbook if the situation does not become clearer soon. At this level of sentiment, they are no longer bearish — but are not yet hopeful either; and they will require some level of certainty to become more risk tolerant.

Asia ex-Japan markets investor sentiment

Sentiment among Asia ex-Japan investors (green line) declined sharply last week on the back of renewed lockdown fears in China and the growing threat to the global economy. There is a feeling that investors had gotten too positive too soon and with too little evidence of an end to the negative forces in play. A slight improvement in the relationship between the US and Chinese regulators regarding onsite audits of Chinese firms listed on US exchanges, together with supportive rhetoric for the economy from the Bank of China (BoC), lifted sentiment in April. However, a lack of concrete steps and a worsening COVD-19 situation in China is quickly erasing those positives and leaving only the negatives for investor to focus on. Most of the improvement in sentiment this past month was due to rapidly falling levels of risk aversion rather than a genuine increase in risk tolerance. Further negative news could easily send risk aversion back up, forcing investors to reverse their recent trades and return to a defensive position.

Global emerging markets investor sentiment

Sentiment among global emerging-markets investors (green line) declined sharply last week, reversing an uptrend that started in late March. Hopes for an early peak in inflation were dashed by the realities of higher US interest rates, a stronger USD and forecasts for a global economic slowdown. Risk tolerance levels declined sharply last week from their recent highs not seen since November last year, while risk-aversion levels, which had dropped to their lowest levels year-to-date, rose. Prolonged uncertainty about the fate of the global economy would be detrimental to investor sentiment in global emerging markets. Meanwhile, the realities of a more hawkish US monetary policy will need to be addressed by discriminating across emerging economies with large current account deficits and USD-denominated debt. Even the commodity-producing countries, which had benefitted from a rise in commodity prices, will suffer if investors believe global growth will decline noticeably, curbing demand.

Japan market investor sentiment

Sentiment among Japanese investors (green line) continued to improve last week on the back of a weaker JPY, but ended off its mid-week peak, showing the first sign of a lack of confidence in four weeks. This failure to turn bullish should be seen in the context of the improvement in risk appetite which has been mostly driven by a dramatic decline in risk-aversion levels rather than a confident surge in risk tolerance. The weaker JPY makes Japanese shares cheaper for foreign investors, who are also hoping for a foreign-exchange gain when the JPY returns to more equilibrium once the USD loses some of its safe-haven status. The 50-bps interest rate hike expected in the US this week is now fully discounted by markets and will likely trigger a bout of profit-taking. If sentiment also declines due to rising volatility and continued uncertainty on the macro front, this could weigh on markets and see them retest their recent lows.

China (domestic) investor sentiment

Sentiment (green line) among Chinese (A-shares) investors fell for the second week in a row on continued fear of further lockdowns across major cities as China battles its worst COVID-19 infection outbreak since Q4 2019. In the near term, sentiment will remain torn between the negative impact of economic lockdowns and the hope for further fiscal and monetary stimulus by the authorities. If sentiment continues to decline, however, markets could come under renewed pressure as investors unwind the risk-tolerant strategies they have implemented since early March.