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ROOF Highlights — November 14, 2023

Qontigo ROOF™ Score Highlights: Week of November 13, 2023

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Potential triggers for sentiment-driven market moves this week1:

  • US: PPI, CPI, industrial production, and retail sales data. Earnings from Home Depot, Cisco, and Walmart.
  • Europe: UK inflation, retail sales, and unemployment data. Eurozone industrial output data.
  • APAC: China updates on new yuan loans, industrial production, retail sales, and fixed asset investment. Japan Q3 GDP growth rate.  
  • Global: Ongoing diplomatic efforts to end the Israel-Hamas war. Biden-Xi meeting on Wednesday in San Francisco.

Insights from last week’s changes in investor sentiment:

Investor sentiment recovered from its lows last week but remains bearish in seven of the ten markets we follow. Of the three markets where investors were not bearish, sentiment rose from negative to neutral in the UK and Australia but declined slightly in China, after the world’s second largest economy fell into deflation last month – sparking fears that the tepid recovery so far, may have just been an illusionary blip.

We note that this kind of ‘sentimental synchronization’ where 70% of investors are ‘feeling’ the same way, is quite rare in our history (going back to 1997) and is usually caused by unique circumstances like the Lehman bankruptcy or massive coordinated regulatory interventions. It is also evidence of investors’ high level of risk aversion and low willingness to speculate in the face of rising macro and geopolitical uncertainty.

Adding to (US) investor worries, are two new issues which have  crept up over the weekend. First, Moody’s changed the outlook of the nation’s debt to negative on Friday after markets closed. Moody’s, the last of the big three to still grant a AAA rating on US government debt, cited the “diminished fiscal strength, undone by extreme partisanship in Washington” as a key driver for its decision. Second, Robert Kennedy Junior, running as an independent, received 22% of the votes in a new poll targeting likely voters. In its article, CNN notes this is significant for two reasons. First, RFK Jr. would be only the fourth, third-party candidate to ever poll above 20% in the history of polling. Second, it reflects the degree of disenchantment voters still have with the establishment.

The last third-party candidate to poll above 20% was Ross Perot in 1992. Republicans blamed him for the re-election loss of George H.W. Bush to Bill Clinton that year. Could 2024 be a replay of 1992 for the incumbent President, and is RFK Jr. a Ross Perot in the making? As for the level of voter disenchantment, it may be time for the Democratic party to dust-off an old Obama quote from his 2008 campaign: “In this election, the biggest risk we can take is to try the same old politics with the same old players and expect a different result”.

With no more earning news after this week, investor focus will return to macro, political, and geopolitical issues, which does not bode well for those hoping for a rebound in sentiment. On the docket this week will be the latest inflation reading for both the US and Europe. Next, retail sales data as well as earnings reports from some of the biggest retailers, to inform investors on the strength of consumer spending. The week will end on a high (low) note with the looming (US) government shutdown deadline on Friday. Come Monday, congress will either have a continuous resolution to keep the government open or be looking for a new Speaker.

Note: green background = bullish, red background = bearish

Changes to investor sentiment over the past 180 days for the markets we follow:

How to read these charts: The top charts show the ROOF ratio (investor sentiment) in green (left axis), against the cumulative returns of the underlying market in black (right axis). The horizontal red line at -0.5 (left axis) represents the frontier between a negative sentiment (-0.2 to -0.5) and a bearish one (<-0.5), and the horizontal blue line at +0.5 (left axis) represents the frontier between a positive sentiment (+0.2 to +0.5) and a bullish one (>+0.5). Around the horizontal grey line at 0.0 (left axis), sentiment can be considered neutral (-0.2 to +0.2).

The bottom charts show the levels of both risk tolerance (green line) and risk aversion (red line) in the market. These represent investors’ demand and supply for risk. When risk tolerance (green line) is higher than risk aversion (red line), there are more investors looking to buy risk assets then investors willing to sell them (at the current price), forcing risk-tolerant investors to offer a premium to entice more risk-averse counterparts to take the other side of their trade, which drives markets up. The reverse is true when risk aversion (red line) is higher than risk tolerance (green line). The net balance between risk tolerance and risk aversion levels is used to compute the ROOF ratio in the top charts, representing the sentiment of the average investor in the market.

The blue shaded zone between levels 3-4 for both indicators, represents a reasonable balance between the supply and demand for risk in the market. Conversely, when both lines are outside of this blue zone, the large imbalance in the demand and supply for risk can lead to an overreaction to unexpected news or risk events.

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1 If sentiment is bearish/bullish, a negative/positive surprise on these data releases could trigger an overreaction.

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