ROOF Highlights — October 12, 2020

Qontigo ROOF™ Score Highlights: Week of October 12, 2020

Potential triggers this week: Third-quarter earnings season with updates expected from Johnson & Johnson, JPMorgan Chase, Citigroup, and Wells Fargo. Brexit talks continue ahead of EU summit Thursday, and WBG/IMF Annual Meetings are also in the spotlight. Key economic data to follow include US retail sales and industrial production; UK jobs report; China inflation and trade balance. 

Summary: Investor sentiment continued to diverge between our Style and Sector ROOF variants last week with the latter being more neutral than the former. In the US, the Style ROOF points to a resurgence of sentiment as investors there await a much-needed fiscal stimulus package and have returned to the most damaged segments of the market ahead of an announcement. On the other hand, the economic recovery has clearly slowed, and as we head into the Q3 earnings season the outlook remains too uncertain to differentiate across sectors at this time. The Covid-19 narrative is worsening, there is political gridlock in both the US and Europe, CEOs are about to speak, and voters right after them. Given this agenda for the next three weeks, we are likely to see investor sentiment remain undecided but cautiously optimistic. Investors, it seems, feel that no matter who sits in the White House next month, their first order of business will be to pass a fiscal stimulus package.  

US Investor sentiment seems conflicted with divergence between style and sector variants. 

The style variant of our ROOF ratio has returned to the bullish zone, breaking out of the neutral zone as investors returned to Q2 favorites, chasing high beta, volatile, small, unprofitable, growth stocks. By contrast, the sector variant remains firmly in the neutral zone, refusing to chase its counterpart upward (top chart). This disagreement can be traced back to the bets being paced on passage of a stimulus package as investors chase the weakest segments of the market in the hope of a repeat of Q2 performance. Conversely, as we head into the Q3 earnings season, most investors prefer to wait-and-hear from CEOs to form an opinion on sector performance. 

The STOXX USA 900 has for now decided to follow the Style ROOF variant and seems in disconnect with the Sector ROOF’s insistence that risk tolerance is declining and risk aversion rising (bottom chart). With Q3 earnings due out over the next few weeks, any positive news from CEOs together with the increased talks of fiscal stimulus, either before or after the election results, could spark a turnaround in the Sector ROOF scores as investors once again raise their expectations for economic growth going forward. Conversely, negative news about the impact of a lack of stimulus on earnings and disappointment with regards to the next package could send the Style Roof scores south again. 

Sentiment in Developed Europe succumbs to rising new infections and heads into neutral.

A worsening pandemic outlook and increasing talks of new measures to combat it weighed on investor sentiment last week with both of our ROOF Variants breaking into neutral territory for the first time in over one hundred days (top chart). As elsewhere, investors in Europe are awaiting clarity on further fiscal stimulus measures as well as a resolution of the post-Brexit trade relationship between the UK and the EU.

The longest consecutive period of positive sentiment was not enough to lift European markets back to their pre-COVID-19 levels. Now, it seems, investors have reached risk-tolerance fatigue. Sentiment ended last week with the lowest level of risk tolerance and the highest level of risk aversion since late April (bottom chart) and although the gap remains slightly in risk tolerance’s favor, sentiment is clearly weakening. It will take another round of coordinated stimuli to lift their spirits back to the bullish zone.

Global investors remain neutral, but Asia ex-Japan continues to be optimistic.

Global investors continue to have their style foot in bullish territory and their sector foot in the neutral zone. Markets seemed to be following the former for now but the divergence points to a lack of confidence on the strength of the economic recovery (top chart). As in the US, the strength of the Style variant seems predicated on a fiscal stimulus package to rescue the weakest segments of the market rather than a belief in the strength of the underlying recovery.

Sentiment in Asia ex-Japan has been mostly positive for the previous five consecutive months but seemed determined to break down to the neutral zone at the end of last week (bottom chart). Both ROOF variants agree with regards to the direction of sentiment, but markets ignored that last week, choosing instead to follow global peers higher on very light volume. The region’s pandemic narrative is one of the better ones but its role in the global supply chain means that any measures taken elsewhere that would impede normal economic activity will affect it. We see the market’s divergence with sentiment as positioning by a few risk-tolerant investors ahead of the US election since September’s market correction will have provided some bargain hunting opportunities.