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ROOF Highlights — November 27, 2023

Qontigo ROOF™ Score Highlights: Week of November 27, 2023

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Potential triggers for sentiment-driven market moves this week1:

  • US: PCE price index, personal income and spending, 2nd estimate of Q3 GDP growth rate, and manufacturing PMI data. Speech from Fed Chairman Powell.
  • Europe: Preliminary November CPI reports for Germany, the Euro Area, France, Italy, Spain, and the Netherlands. Speeches by ECB President Lagarde.
  • APAC: China PMI data, Japan retail sales, industrial production, and speeches by BoJ officials.
  • Global: Investors are waiting for either an extension to the ongoing truce between Israel and Hamas, or the resumptions of hostilities. They will also keep a wary eye on renewed attacks on Kyiv in Ukraine, and carefully parse speeches by both Powell and Lagarde this week.

Insights from last week’s changes in investor sentiment:

Investor sentiment continued to recover last week with only one market (Asia ex-Japan) remaining bearish as of last Friday. Investors in China remained bullish (or hopeful?), despite the market’s reluctance to rise without further evidence of a credible economic recovery. Elsewhere, sentiment was still negative in Global developed markets, Global emerging markets, and Europe, neutral in Global developed ex-US markets, Japan, and the US, and turned positive in Australia and the UK.

Key to the recovery in both markets and investor sentiment was a (much) better than expected Q3 earnings season, signs that the economy is (finally) responding to the tight monetary conditions, improving geopolitics in the background with the reopening of communication channels between the US and China, and the start of a truce in the Israel-Hamas war. To paraphrase William Dean Howells, what investors want in the news is a tragedy with a happy ending2.

The other big contributing factor to a rising risk tolerance is the declining market risk. After a short rebound at the start of Q4, volatility has resumed its downtrend, ending the week well below its long-term median in all markets we follow. For its part, sentiment is still recovering from its early November bearish lows, and investors’ willingness to speculate is nowhere near dangerous (greed) levels. Add to this the large upward revisions to the Q1 and Q2, 2024 earnings forecast on the back of the recent reporting season, and unless geopolitical events cancel the happy ending, markets could well continue to rise for the rest of the year.

The argument against, continues to come from the markets’ lack of breadth and volume, which remains concentrated around technology stocks and the artificial intelligence theme in particular. The danger comes when a rising willingness to speculate combines with a seemingly risk-less ambition from low volatility readings, resulting in an inability to say no to high valuations. We may have already reached that point in certain crowded segments of the market. Time to diversify.

Uncertainty from both the macro and geopolitical sphere remains elevated. The truce in the Israel-Hamas war has so far only bought us another two days of calm. The war in Ukraine is flaring up again with renewed attacks on Kyiv. European governments are in a fiscal bind, needing to cut expenditures to meet the EU’s budget requirements at a time when the economy needs them to increase spending. And the US political landscape ahead of next year’s Presidential elections looks like a giant Jackson Pollock painting; splotched, colorful, and completely random.

As far as investors are concerned, for the next twelve months or so, central bankers are the only adults in the room, and they will pay more attention to what Jerome Powell and Christine Lagarde have to say than the sound bites from the campaign trail. The current consensus (conspiracy?) is that the Fed will start cutting rates in May 2024, the ECB, maybe sooner, to avoid a hard landing. Investor sentiment will continue to be moved by confirmations or denials of this pivot timing.


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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Asia ex-Japan:

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Australia:

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China:

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Developed markets:

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Developed markets ex-US:

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Emerging markets:

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Europe:

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Japan:

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UK:

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US:

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

2 If He was referring to the American public’s taste in movies.

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