ROOF Highlights — May 31, 2021

Qontigo ROOF™ Score Highlights: Week of May 31, 2021

Potential Triggers: US job report on Friday, worldwide manufacturing and services PMIs, and European inflation numbers will provide investors with an update on the economic recovery as well as supply constraints and price pressures.

Summary: Last week started with a fog and ended with a yawn. It appears investors’ earlier concern about inflation has become a kind of shrug-the-shoulders-and-accept-it resignation, inferring a belief that temporary price pressures may just be the natural cost of doing (stimulus) business. All markets we track except China have remained transfixed in the neutral zone, clearly awaiting direction from this Friday’s US job report or perhaps next week’s May CPI numbers. Indecision, however, should not be mistaken for indifference. Sand runs down through the hourglass and any castles built in there can easily fall apart should interest rate tremors once again raise their ugly head with the news of lower-than expected unemployment, or higher-than expected inflationary pressures. Note that news there was nothing to worry about is equally likely and given that the global vaccination drive now well underway is bringing us ever closer to a return to normal, sentiment (and markets) could get a real boost from a benign inflation report card next week.

US investors recover from the Yellen Put and regain their holding pattern in the neutral zone.

US Investors’ sentiment has returned to the neutral zone this past week and seem no longer a drag on upward market moves (top chart). The short-trading week will culminate with the all-important May jobs report, giving investors yet another read on the state of the economic recovery. Given the Fed’s new focus on full employment, a stronger-than expected jobs report may reignite inflation fears and send sentiment south of the neutral zone again. Conversely, a weaker-than expected jobless rate will convince them that monetary easing is here to stay, for a while longer at least.

Risk aversion (red line) retreated last week while risk tolerance (green line) rebounded to bring the supply and demand for risk closer to equilibrium (bottom chart). Risk-averse investors still outnumber risk-tolerant ones but the narrowing gap between the two camps means that over-reaction – in either direction- is unlikely in the near term.

European markets rise as investor sentiment remains non-committal.

Both European ROOF ratios remained in the neutral zone last week indicating a lack of commitment in either direction from investors for the time being (top chart). Markets, however, continued their recent climb, focused on economic recovery. Inflation in Europe is not as near the ECB’s 2% target and therefore not yet affecting sentiment in the same way as it is in the US.

Risk aversion (red line), however, remains on an upward path and despite a last-minute turnaround by risk tolerance (green line) late last week, is well on its way to close the gap (bottom chart). As long as risk-tolerant investors outnumber risk-averse ones, markets may continue to ignore a deteriorating sentiment since late April, but a change in this relationship could spark a wave of profit taking before the summer months – or worse – during. For now, equilibrium seems de rigueur but with PMI and eurozone inflation data due out this week, their neutrality may be tested.

Sentiment among both Global Developed and Asia ex-Japan investors remains neutral.

Global investors’ sentiment recovered slightly from the bottom half of the neutral zone last week, to end at almost perfect equilibrium between the supply and demand for risk (top chart). Sentiment has been on a slow but continuous recovery path since mid-March, mildly supportive of higher market prices. In these conditions, a sharp move to the downside is as unlikely as exuberance to the upside, shielding investors from market over-reaction to this week’s macroeconomic data releases.

The decline in sentiment holding Asian ex-Japan markets back in early May, halted last week ending completely neutral (bottom chart). It remains to be seen where sentiment goes from here but if the hold fast at these levels, it is unlikely to cause much of a pull back from current market levels. The recent flareups in new Covid-19 infection cases in the region seem to be under control with localized lockdown measures, and sentiment does not seem to be headed lower for the time being.

Sentiment lifts both Japanese and Chinese markets higher.

Japanese investors’ sentiment rebounded sharply last week from the bottom of the neutral zone to nearer the top (top chart). At these levels, investors are not yet bullish but hopeful things are on an improving path and are likely to see any positive news as reason to buy and, conversely, will need strongly negative news to develop a need to sell.

Sentiment has remained at YTD highs for three consecutive weeks now in China (bottom chart). This persistent positive cognitive bias finally pulled markets higher in their strongest week since returning from the Lunar New Year holiday in mid-February. Investors seem to have put aside worries about potential US-China conflicts under the new Biden administration to focus instead on the strength of the global economic recovery. If this sentiment pull persist, markets could regain their February high water mark.