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ROOF Highlights — October 25, 2022

Qontigo ROOF™ Score Highlights: Week of October 25, 2022

Potential triggers for sentiment this week1 :

  • US: Earnings reports from Coca cola, GM, Alphabet, Microsoft, Spotify, Visa, Boeing, McDonald’s, Ford, Meta Platforms, Mastercard, Amazon, Apple and Intel. Preliminary Q3 GDP estimate, durable goods orders, flash PMI data.
  • Europe: The ECB is highly expected to deliver another 75-bps rate hike on Thursday. Q3 GDP figures for Germany, France and Spain, and PMI data for the Eurozone and the UK.
  • APAC: China Q3 GDP, Japan PMI.
  • Global: Short-term, any increased probability of nuclear weapons being used in Ukraine. Medium- to long-term, the status of the US-China relationship.

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:

  • Investor sentiment ended last week bearish in all markets we track for the second week in a row. Investors seem no longer hopeful of a central bank pivot in November or December, and continue to implement risk-averse strategies. Where there is a strong bearish sentiment, reason will relax its watch upon the gates of objectivity, and self-fulfilling prophecies rush in pell-mell as negative interpretations of headlines makes for better reading than positive ones.
  • Uncertainty about key macroeconomic and geopolitical assumptions remains high. The consensus for now seems to be that things will get worse before they get better, and even have the potential to get horribly worse. Uncertainty combined with a bearish sentiment means that overreaction is more likely (e.g., Hong Kong’s Hang Seng Index’s 6% fall on Monday).
  • Exposition is ammunition for investors — they fire it when they need it. Low volumes indicate that most investors still think that any investment thesis made in this uncertain environment resembles the analysis of a forest without recourse to any description of a tree. To quote Montaigne: “To be cured of ignorance, one must first confess to it”. In this light, the persistent bearish mood of investors these past few weeks could be seen as a sort of confession, but absolution may yet be withheld for a while longer.
  • There are a lot of potential triggers for sentiment this week (see list above), and about a third of S&P 500 companies will be releasing Q3 earnings reports. The 20% that have reported so far have not been able to deflect the negative mood of investors, who have doled out harsher punishments for misses than the rewards for positive surprises.
  • Geopolitics, the third wheel of economic theory after monetary and fiscal policy, continues to be too difficult to predict with any confidence. And, as the events of the last two months in the UK have shown, both monetary and fiscal policy forecasts are on shaky grounds themselves. Not to get biblical about it, but constructing portfolios in these circumstances without heeding to sentiment, “is like a fool who builds his house upon the sand” (Matthew 7:24-27). Best advice in those times: Don’t.

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US investor sentiment

Sentiment among US investors (green line) ended the week bearish but off its mid-week lows, as hopes for a less aggressive rate hike by the Federal Reserve at their December meeting lifted sentiment on Friday. Risk aversion remains well above risk tolerance, turning any disappointing earnings release this week into a potential trigger for downside overreaction by investors. Expectations were already lowered ahead of the reporting season, but investors have so far been hard graders, punishing earning misses and sometimes ignoring beats (Tesla). CEOs will need to provide guidance on multiple fronts this time around, adding the impact of a strong US dollar to their list of headwinds that already includes higher interest rates, inflation and a slowing economy. On the latter, employment and consumer spending remain resilient and still provide tail winds for some segments of the economy. Welcome back to the old normal, where interest-bearing instruments compete with risk-bearing ones for investors’ attention.

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European investor sentiment

European investors’ sentiment (green line) ended last week slightly more bearish than the previous week. This week’s European Central Bank rate decision together with the latest reading on the German economy will determine if sentiment can recover, pulling markets up with them, or if it will become increasingly bearish. A more stable political situation in the UK over the weekend will help sentiment until Thursday, but investors are still trying to gauge by how much they should discount the current economic slowdown. Stagflation remains the base case and has been gradually priced into current valuations, but neither the depth or duration of the slowdown are known with clarity, and both forecasts are subject to revisions as data is released. A bearish sentiment means that investors will react to a single negative data point, but will require multiple positive metrics before they regain confidence that the selling is overdone and start to adopt a more risk-tolerant approach to markets.

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Global developed markets investor sentiment

Sentiment among global developed-markets investors (green line) ended the week less bearish than the previous week, providing support for global markets. Global investors have faced additional pressure this year with the surging currency volatility, driven mostly by the US dollar’s strong safe-haven status during times of geopolitical conflicts. Relative stability in the currency markets last week helped investors regain some confidence but sentiment remains bearish and susceptible to downside overreaction in these very uncertain conditions. Currency stability can prevent further deterioration in sentiment but will not be enough by itself to reverse the downward trend since August. A more favorable outlook for interest rates and inflation is still some months away. Investors will need some time to adjust to the new normal, with the only historical data points to help guide them having to come as far back as the late 1970s. Meanwhile the geopolitical outlook has worsened with tensions growing on multiple fronts (US-China, Nato-Russia, US-Iran, North Korea-South Korea, China-Taiwan) and become more unpredictable.

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Asia ex-Japan markets investor sentiment

Sentiment among Asia ex-Japan investors (green line) ended last week very bearish, but not as seemingly hopeless as the previous week. Still, the deterioration in sentiment since the highs reached in late August is substantial and marks the strongest reversal since the Covid-19 crash of Q1 2020. The key drivers behind this negative trend are higher US interest rates, a stronger US dollar, a slowing global economy and trade, prospects of further lockdowns under China’s ongoing Zero-Covid policy, and increasing tensions between the US and China over Taiwan. At this point, there are just too many strong headwinds for investors to ignore, and while valuations are already lower than pre-Covid, they seem headed even lower than their Covid-crash lows. The November and December interest-rate decisions in the US could be the nail in Asia’s valuation coffin. Risk-averse investors outnumber risk-tolerant ones almost two to one currently, making the Heng Sang index’ 6% fall on Monday a common feature of this kind of extreme (bearish) sentiment.

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Global emerging markets investor sentiment

Sentiment among global emerging-markets investors (green line) remained very bearish last week, hoovering around the same low levels of the previous week. In addition to the negative macro pressures that are felt by Asia ex-Japan investors, global emerging markets have to contend with the fact that China is the largest component of the region’s indices, and that the second-largest economy in the world is slowing down, fast. Investor sentiment has relied heavily on the cooperation these past two decades between the US and China. Today, investors view with skepticism the combination of the latest changes in China’s top leadership and an expected resurgence of Republican influence in the US congress after next month’s mid-term elections. With the two economies’ political regimes moving in diametrically opposing direction, there is a rising probability that the past cooperation turns into open competition, with the two largest economies in the world working against each other instead of with one another. This scenario raises the stakes for investors as both the US and China vie for influence over emerging markets. Those concerns are unlikely to be assuaged until after the November 2024 US presidential elections.

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Japan market investor sentiment

Sentiment among Japanese investors (green line) fell to new bearish lows last week. Japan was the only market we track in which sentiment deteriorated from the previous week. A large influence on the recently accelerating decline in sentiment comes from the currency market, where the yen fell below 150 to the USD last week. The Bank of Japan’s monetary policy remains at odds with those of other major central banks, despite both broad and core inflation being above its 2% target since April this year. Consumer spending, 60% of GDP, has been resilient so far in Japan, but the sharp decline in sentiment since the announced reopening of the country from lockdown measures in July, indicates that investors are increasingly worried about this last bastion of economic strength. A pivot to a hawkish monetary policy by the BoJ at the same time as evidence grows of an economic slowdown will further exacerbate investor sentiment. With risk aversion now almost twice as high as risk tolerance, Kuroda-san may have missed the chance for a painless pivot.

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China (domestic) investor sentiment

Sentiment (green line) among Chinese (A-shares) investors has been somewhat spotty these past three weeks in view of the week-long holiday and the ongoing Communist Party Congress, which is held once every 5 years. Investors ended last week bearish, but with the implications of last Sunday’s announcements being ahead of us, sentiment will only begin to show a reaction to the announced changes from this week onward. The currently bearish sentiment reflects the fact that recent macro data is lower and does not converge with the official forecast for economic growth for the full year, with only two months to go. Questions remain on the status and future of the US-China relationship, so vital to both the global and China’s own economic growth. In China President Xi has further consolidated his power and reaffirmed the possibility of using force to reunite China and Taiwan. In the US, next month’s mid-term election will likely result in a growing influence from the conservative wing of the Republican party in Congress. Until clarity returns to this all-important relationship, sentiment and markets are likely to remain under pressure.

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