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ROOF Highlights — May 30, 2022

Qontigo ROOF™ Score Highlights: Week of May 30, 2022

Potential triggers for sentiment this week1 :

  • US: Jobs report, manufacturing, services PMI data.
  • Europe: Inflation data for Germany and France.
  • APAC: China manufacturing PMI data, Australian Q1 GDP.
  • Global: Daily news flow out of Ukraine, geopolitics in the South Pacific, and weather events.

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 remained bearish in the US and global developed markets last week, and negative in Europe. In contrast, sentiment continued to recover in Asia ex-Japan, global emerging markets and China, on the back of the Chinese government’s pledge to provide economic, fiscal and monetary support. Sentiment in Japan ended the week off its highs but still positive, after failing to become bullish for a fourth consecutive week.
  • Macroeconomic uncertainty will remain high for the foreseeable future, but we note that investors implemented risk-averse strategies for the better part of 2021 on inflation concerns, and have done so as well for all of 2022 to-date. This prolonged popularity of risk-averse assets versus risk-tolerant ones, has made the former rather pricey and the latter potentially attractive again. This helps explain bouts of bargain-hunting among tech stocks.
  • The war in Ukraine must end for sentiment to have a chance at a full recovery and become bullish again. Only then will the pendulum decidedly swing in favor of risk-tolerant assets and support a rotation out of risk-averse ones, and lead to a sustainable market recovery. Pending this event, investors will continue to favor investment strategies that prevent a lot of money from becoming a little.
  • It has been said that the chief motivation of capitalism is greed, and that of communism envy. Putin’s envy of Ukraine began a long time ago, when his geopolitical ambitions were still in their incipient, not yet tyrannical, stage. He will not stop now. This war will go on, and while it does, risk tolerance will remain a speculative contrarian strategy of trying to turn a little money into a lot.
  • As we head into the summer months, investors will become increasingly sensitive to extreme weather events. Under the ongoing influence of La Nina, meteorologists are predicting a hotter-than-usual summer for both the US and Europe. As a prelude, March was the hottest month in 122 years in India. Welcome to climate changed.

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US investor sentiment

US investor sentiment (green line) bounced off its recent low from the previous week, to end last week still bearish but not as hopeless. A more positive set of corporate earnings lifted sentiment, but uncertainties on the macro and geopolitical front remain in place, potentially preventing a more sustainable recovery in the near term. Risk aversion remains the preferred strategy over risk tolerance, translating into a still negative risk appetite among investors. Given this imbalance in the potential supply and demand for risk assets, negative news will continue to have more impact on markets than positive news, as investors look for confirmation that they were right to be bearish all along.

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European investor sentiment

European investors’ sentiment (green line) halted its decline of the previous week, returning to the (less) bearish levels of March, and ended last week only slightly negative. The current level suggests investors are not positive but are still hopeful that the situation will not get worse. Stalemate in eastern Ukraine, the de facto situation there since 2014, may be a plausible reality European investors are beginning to price in — but not one they are likely to get. Comments over the weekend from both sides continue to point to an all-or-nothing endgame in Ukraine. As of last week, the potential supply and demand for risk assets in Europe is at equilibrium, with neither risk aversion nor risk tolerance being dominant with investors. At equilibrium, risk assets tend to change hands at or near current levels, leading to a sideways market until news flow sways sentiment in either direction.

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Global developed markets investor sentiment

Sentiment among global developed-markets investors (green line) drifted lower last week, ending marginally more bearish than the previous week. Sector allocations (red dotted line) now point to the implementation of risk-averse strategies by most investors in the face of prolonged macro and geopolitical uncertainty. Elevated levels of currency risk and a lack of progress on reigning in inflationary pressures, together with a rising probability of recession across major economies, is weighing on global investor sentiment. Additionally, the first batch of evidence that profit margins are coming under pressure from rising costs, and signs from the tech sector that the strong recovery in employment may have peaked, is also leading investors to question earnings forecasts for both this and next year. Risk aversion is now the dominant strategy for investors and the potential supply of risk assets in the event of negative or worse-than-expected news could trigger another sell-off, and is certainly not supportive of last week’s market rebound. The holiday-shortened week in the US, HK, and UK (next Monday) could see some profit-taking.

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Asia ex-Japan markets investor sentiment

Sentiment among Asia ex-Japan investors (green line) rebounded last week to end neutral from mildly bearish the previous week. News from Chinese authorities about further fiscal and monetary stimulus to help the world’s second largest economy recover from prolonged lockdown, lifted risk-tolerance levels, and triggered a rotation out of risk-averse assets for the first time since April. The supply-and-demand balance for risk assets ended the week at equilibrium but with positive momentum for risk appetite in the short term. An absence of negative news on the geopolitical front should allow investors to focus on the local and regional news flow this week, but the negative trend in macro fundamentals, a stronger US dollar, and higher US interest rates, will continue to cap any upside potential and prevent sentiment from returning to bullish levels, last seen in November 2021.

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Global emerging markets investor sentiment

Sentiment among global emerging-markets investors (green line) rose last week, ending positive, on the back of Chinese authorities’ stance to stimulate their economy. Macro fundamentals remain negative for emerging markets, with a strong dollar, higher US interest rates, and continued extreme weather events, in the form of floods and heat waves, disrupting the supply chain. The ongoing Russian blockade of major Ukrainian ports is also disrupting the supply of grain to this part of the world, already facing dire food shortages. Despite this macro picture, risk aversion declined last week while risk tolerance rose, resulting in a marginally positive net risk appetite for investors. Absent concrete improvements in the fundamentals, improved sentiment will only provide a floor for markets and not support a more sustainable rebound.

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Japan market investor sentiment

Sentiment among Japanese investors (green line) failed to become bullish for the fourth week in a row, ending positive but slightly lower than the previous week. Investors in this market have been waiting for news that would allow them to become bullish, but have instead heard nothing positive out of Ukraine, inflationary pressures, or global economic growth. Meanwhile, the Japanese Yen has strengthened from the 130 level against the USD, to 127. As in other markets, a positive sentiment is not enough to sustain a market rally, and unless investors can become confidently bullish, they will not hold on to risk-tolerance assets for long, returning to the safety of risk-averse ones after only a few days or weeks. This pattern is likely to repeat itself until more clarity returns on the global economy front.

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China (domestic) investor sentiment2

Sentiment (green line) among Chinese (A-shares) investors continued to rise steadily last week, supported by further assurances of pending monetary and fiscal stimuli from regulators. Investors have been consistently bearish during the first four months of the year, recovering in May only once the authorities announced the end of the lockdowns in major cities, becoming positive for the first time since late November 2021. Year-to-date, the CSI300 index is deep in bear-market territory, having lost more than 20% of its value in dollar terms and only slightly better in yuan. Talks of stimulus is helping risk tolerance recover from its low levels but risk aversion is not declining as fast, suggesting investors maintain a negative bias until they see the stimulus working. Until then, they will not completely rotate out of risk-averse assets.

2 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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