ROOF Highlights — May 9, 2022

Qontigo ROOF™ Score Highlights: Week of May 9, 2022

Potential triggers for sentiment this week1 :

  • US: Inflation data, Fed official speeches, consumer confidence data.
  • Europe: UK March GDP data, Eurozone industrial production.
  • APAC: China inflation numbers and trade data.
  • Global: Putin’s WW2 Victory Day speech on Monday will set the mood for the rest of the week. He will need to explain why Volodymyr Zelenskyy is starring in his production of “Violence of the Lambs”, and what he plans to do about it.

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 sentiment that began in March and peaked during the last week of April is showing signs of weakening. Sentiment in five of the seven markets we track is now back in negative territory, with investors in the US ending the week bearish. Stubbornly high inflation, Russia’s invasion of Ukraine, and COVID-19 lockdowns in China, remain top-of-mind for investors. This will not change this week.
  • On inflation, investors are no longer asking, “How did inflation get this bad?”. They’re asking “Why wasn’t more done to stop it sooner?”. They want central banks to stop being just allies in the fight against inflation but become accomplices and to stop hedging between inflation and the economy, like a cuttlefish squirting out ink to cover its track. The economy is fine. Consumers are not. And consumers decide future economic growth. Investors feel it is time for central banks to pay it forward.
  • On Russia, to paraphrase Orwell, its leadership is like a dysfunctional family with the wrong members in control. Complete with closets bursting with skeletons, and a deep conspiracy of silence about the source of its wealth. Still, like a family it closes ranks when threatened, and Putin is expected to officially name and declare war on the enemy closing in on them during his WW2 Victory Day speech.
  • On lockdowns in China, President Xi has doubled down on his zero-COVID policy, with a stern warning to anyone — foreign or domestic — who questions it. Beijing has also installed a hardliner as the new governor of Hong Kong, thereby extending that message to the city state, leaving the prospects for further lockdowns intact.
  • This week is likely to be a turning point for sentiment, with the optimism of the past month unraveling in the face of wavering central banks and hardliners weighing on geopolitical pressure points. The sudden rise in antagonism and current lack of conciliatory dialogue from either direction, means uncertainty will remain high, and rising market risk will drive more investors to the risk-averse segments of markets and away from the risk-tolerant ones.

US investor sentiment

US investor sentiment (green line) ended the week bearish for the first time since late March on the back of rising geopolitical risks and macroeconomic concerns. The jobs report confirmed the current strength of the economy, but investors remain worried about the negative impact a prolonged period of high inflation could have on both the economy and corporate earnings. The two key sources of higher consumer prices — the war in Ukraine and lockdowns in China — were given a second wind this past week sending risk appetite down as investors take cover. The risk-averse segments of the market are likely to remain more popular until clear signs emerge of a possible truce in Ukraine or declining COVID-19 new infection rates in China.

European investor sentiment

European investors’ sentiment (green line) continued its remarkable recovery since late March ending the week strongly positive, but not yet bullish. Sentiment is now the most positive it has been since September last year, as investors continue to implement risk-tolerant strategies through their sector allocation (red dotted line). The resilience of European investors in the face of a still highly fluid and uncertain situation in Ukraine seems counterintuitive and can only be explained in the face of an ECB that remains dovish and accommodating. Markets fell last week, despite rising sentiment, as investors continued to unwind risk-averse positions they have been accumulating since late November last year, while cherry-picking risk-tolerant ones. Given the sharp contrast between bond yields in the US and Europe, this apparent risk tolerance may be more due to a lack of options than a real choice. Geopolitics this week is sure to test their resolve.

Global developed markets investors sentiment

Sentiment among global developed-markets investors (green line) was directionless last week, ending just above the border between bearish and neutral, where it has been for the past two weeks. This is the third attempt at reaching positive sentiment levels after the failures in November 2021 and February of this year. Each failure to rise above this level was met with a test of the previous lows. The fact that markets are down but sentiment has continued to rise these past few weeks simply means that risk-tolerant assets have not suffered as much as risk-averse ones, but it does not signal a return to a bullish risk appetite. US investor sentiment has already fallen back into a bearish state, Japan has been mostly closed for the Golden Week holidays, and sentiment in Europe has been on a recovery path, which helps explain the divergence between sentiment and global markets this past week. More bad news this week on the geopolitical front could turn Japanese and European investor sentiment into reverse as market losses erode their tolerance for risk.

Asia ex-Japan markets investor sentiment

Sentiment among Asia ex-Japan investors (green line) ended the week flat with most investors focused on the threat to the global supply chain from lockdowns in China. Market holidays in China, Hong Kong and Japan kept trading volumes low and most investors on the sidelines. Investors in the region will most likely take their cues from those overseas and will also keep a weary eye on rising US bond yields as an indication that funding costs in the region will soon rise further. Looking at the supply-and-demand balance for risk assets over the past few weeks, demand has been in reverse for the last fortnight and only a continuing decline in risk aversion has kept supply from rising and net risk appetite from falling. This could change as investors return to markets from Tuesday onwards.

Global emerging markets investor sentiment

Sentiment among global emerging-markets investors (green line) ended the week neutral after declining in the previous week. The twin negatives of higher US interest rates and lockdowns in China is weighing on sentiment and keeping investors wary of implementing contrarian risk-tolerant strategies. As with Asian ex-Japan investors, risk tolerance has been reversing course in the past two weeks and only a flat level of risk aversion has allowed sentiment to remain neutral until now. A strong reaffirmation of China’s zero-COVID policy stance over the weekend will dash all hopes for an early end to the lockdowns and possibly lead to further downgrades of the country’s economic growth forecasts. For sentiment to remain neutral, regulators will need to communicate the prospect of further monetary and/or fiscal stimulus (i.e., make equities the only choice).

Japan market investor sentiment

Sentiment among Japanese investors (green line) ended the holiday-shortened week flat. Sentiment recovered strongly in April (from very bearish levels to strongly positive, but not yet bullish), on the back of a depreciating JPY and a dovish monetary policy. A weaker currency is a positive for the Japanese market, but this initial catalyst will have to be followed with stronger global economic growth forecasts to be sustainable. A deteriorating geopolitical narrative will also have a dampening impact on sentiment, potentially causing risk-aversion levels to rise again.

China (domestic) investor sentiment

Sentiment (green line) among Chinese (A-shares) investors declined slightly during the only two days the market was open last week. Most of the market and sentiment-moving news happened over last weekend with an authoritative call for the country’s zero-COVID policy not to be challenged in any way, dashing hopes for a return to normal in the affected cities. Putin’s WW2 Victory Day speech on Monday could also put some pressure on the Chinese leadership to choose a side in this conflict as an official declaration of war from Russia on Ukraine cannot easily be ignored in the official press. Chinese investors are entering the new week in a state of neutral risk appetite and it will be up to the state media to sway them one way or the other.