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ROOF Highlights — October 3, 2022

Qontigo ROOF™ Score Highlights: Week of October 3, 2022

Potential triggers for sentiment this week1 :

  • US: manufacturing and services PMI data, September jobs report.
  • Europe: ECB meeting minutes and President Lagarde’s speech, retail sales data.
  • APAC: Japan’s Tankan survey data, China’s services PMI data.
  • Global: The unpredictable risks of further escalation in the conflict in Ukraine, as Putin’s war now has the potential of going from a figure of speech, to one that leaves you speechless. At this point, no one can guess when or how this war will end (hint: this isn’t a western story, it is a Russian one).

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 negative in all markets we track, with investors in global developed markets, Asia ex-Japan and China remaining bearish. Sentiment in the US, developed Europe, and Japan, stopped short of becoming bearish but remains very negative. Investors in global emerging markets turned negative for the first time since June but may head lower soon on the back of declining commodity prices and global recession fears.
  • The ongoing war in Ukraine is a key factor behind the lack of predictability for investors right now. Vladimir Putin, that late-twentieth century communist wit, is a man who plays his cards not so much close to his chest as inside his shirt. To quote Johnathan Swift on religious faith, “you cannot reason someone out of something they have not been reasoned into”, and paranoia is Putin’s religion. “My war, wrong or wrong” could be his recruiting motto.
  • For another week or two, macroeconomic and geopolitical news, with a few twists of fate thrown in from climate change, will still dominate the headlines. These events tend to increase both market volatility and correlation, and decrease stock level dispersion by chipping away at the confidence investors have in their forecasts. These uncertain market conditions will continue to weigh on sentiment in the short term.
  • Uncertainty is a killjoy for investors, and since Putin is not sharing his playbook with them, CEOs will need to address investors’ concerns. The few companies we have heard from recently have been very vague about their lower guidance, spooking investors more than reassuring them. Investors want information, not generalities. My advice for the upcoming earnings season is for CEOs to be as upfront and specific as possible about their results, the key success factors they are monitoring, and what their plan is to navigate through the current global economic slowdown. Anything short of full disclosure will not do.
  • The average investor is now either very negative or outright bearish. This increases the probability that emotions will impact decision-making and that we will see more overreactions to negative news in the short term. Only an early, and peaceful, end to the war in Ukraine, or consecutive monthly declines in inflation, will bring sentiment back up at this point. Risk-averse strategies should continue to outperform risk-tolerant ones, as they have done since Q1 2021. Downside risk for equities is made even larger than in previous years by the availability of safe investment alternatives for cash positions (i.e., FOMO is no longer a thing).

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US investor sentiment

Sentiment among US investors (green line) stopped short of becoming bearish last week, ending slightly above the previous week’s reading but still very negative. This pause in the decline in sentiment may simply reflect uncertainty about whether the year-to-date fall in valuations is sufficient to match an expected decline in corporate earnings. This question will only be answered once the Q3 earnings reporting season gets underway. On investors’ mind is how companies will weather ongoing supply chain disruptions, higher production costs from rising inflation, the impact of higher interest rates on their finances, and how they plan to address forecasts for a global economic slowdown. In times of heightened uncertainty, the best communicators will be rewarded. Those who fail to provide detailed answers to these questions will see their stocks sold as investors navigate to more information-friendly companies. Risk-aversion levels are higher than risk-tolerant ones right now, and geopolitics has the potential to push risk appetite even lower in the short term, making downside risk protection the most popular strategy to implement until the uncertainty has been lifted (i.e., better safe than sorry).

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European investor sentiment

European investors’ sentiment (green line) ended the week unchanged from the previous week, but still moderately negative. In addition to the above-mentioned macroeconomic risks, Europe’s economies also face a new right-wing government in Italy, confusion between its monetary and fiscal policies in the UK, additional natural gas delivery disruptions from Russia, and a dangerous escalation in the rhetoric around the war in Ukraine on its eastern front. Given these uncertainties, sentiment still seems higher than it has the right to be. This could be another case of investors hoping that regulators will bail them out once more, as a rise in popularism gradually grows among Europe’s largest economies. The Eurozone, along with the complexities of a large economic bloc, has the inferiority complex of a small country. Investors there tend not to get too worked-up about gloomy forecasts because they have too much current reality to deal with already. The Eurozone’s heavy bureaucratic hand and regulatory oversights means investors are dealing with a very domesticated notion of market risk. The feeling seems to be that if things get any worse, surely regulators will step in to help, like they did in the UK last week. In the short term, sentiment remains above the bearish levels at which emotional overreaction occurs, which could be enough to allow markets to recover some of their recent steep losses.

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Global developed markets investor sentiment

Sentiment among global developed-markets investors (green line) continued to decline, becoming increasingly bearish. Global investors must deal with an additional layer of risk from exchange rate volatility. The latter has increased sharply in recent weeks due to a combination of a growing dislocation in the monetary policy of major central banks and strong safe-haven status of the US dollar (USD). Higher currency-hedging costs put more pressure on the return forecasts for global equities at a time when confidence in those is reduced by rising macroeconomic and geopolitical uncertainty. Add to this the still small, but now real, alternative in the form of available USD-based risk-free returns, and global investors must now not only defend their stock picking allocation choices to investors, but their asset class allocation choices as well. Fear of missing out (FOMO) has in previous years been partly responsible for bargain-hunting and bottom-picking by investors who really had no other investment choices. This is no longer true, taking away the sense of urgency in jumping back into equities after a market selloff. In the current environment, it is safer to play the trends than to try and guess the turns of a market.

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Asia ex-Japan markets investor sentiment

Sentiment among Asia ex-Japan investors (green line) fell further last week, ending at its most bearish levels since March of this year. Regional investors are now the most bearish across all markets we track. Most of the region’s currencies and monetary policies are loosely pegged to the USD and US interest rates. This is a double negative for most regional economies that are driven by exports or re-exports. Add to these woes the fact that the region’s second pillar of wealth generation, after the stock market, is property speculation, and you have something for regulators to really worry about. Stocks have underperformed, but the property market has held up well so far, even in the face of rising interest rates, but it is starting to show signs that it too may be about to enter a correction phase. Covid-19 cases are on the rise again following regional reopenings, and with the advent of winter, investors are worried about a return to lockdowns if new infections get out of hand. The US-China relationship is also weighing on sentiment for longer-term (institutional) investors. And so, with not much positive news to look at, sentiment is likely to remain bearish in the near term and to prevent markets from recovering even their recent high-water mark levels reached in early August.

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Global emerging markets investor sentiment

Sentiment among global emerging-markets investors (green line) continued to decline last week, ending negative for the first time since mid-July. Sentiment had remained higher than in developed markets, helped by the continued rise in commodity prices, benefiting those markets that export raw materials to the developed world. With the recent drop in oil prices along with a few other commodities, and the growing consensus of a global slowdown, sentiment among emerging-markets investors has turned downward, with risk aversion now higher than risk tolerance. The news over the weekend that OPEC is planning to cut oil production is yet another vote casted in favor of slower global demand going forward, which should continue to negatively impact sentiment for investors. Valuations have declined all year, and sentiment is still far from bearish, but there seems no urgency in jumping back in when the bottom remains too unpredictable to call (i.e., things could get worse, much worse, before they even appear to be getting better).

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Japan market investor sentiment

Sentiment among Japanese investors (green line) deteriorated sharply last week, falling from neutral the previous week to almost bearish. Both sentiment and markets are now back down to their June 2022 lows but still above their lowest levels reached in March this year. Part of the explanation for this outperformance versus global peers is the fact that the BoJ is still in quantitative easing mode, having just announced that they would maintain their asset purchasing program “indefinitely” for now. Last week’s sharp decline in sentiment hints at a lack of confidence in the BoJ on the part of investors, and with the Japanese market having declined much less than developed markets year-to-date, there could be plenty of downside left if sentiment continues to decline and becomes bearish.

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China (domestic) investor sentiment2

Sentiment (green line) among Chinese (A-shares) investors recovered slightly last week but ended still bearish. In addition to the macroeconomic and geopolitical worries it shares with global investors, domestic investors in China also worry about the return of COVID-19 lockdowns should new infection cases start to rise with the coming winter weather. Add to this the growing tensions between Beijing and Washington over the issue of Taiwan, and there isn’t much for Chinese investors to get more positive about. Valuations have suffered the most among the markets we cover, which may be the only silver lining for investors now, but corporate earnings remain susceptible to further downgrades once the length and depth of the global economic slowdown becomes known. At this point, as in other global markets, not much negative corporate news has been priced in, making the upcoming earnings reporting season that much more critical for sentiment going forward.

2 Note that as of the end of May 2022, we have switched to using a core benchmark as estimation universe instead of the broad market portfolio to better capture the behavior of institutional investor by removing the small caps from our analysis.

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