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ROOF Highlights — October 30, 2023

Qontigo ROOF™ Score Highlights: Week of October 30, 2023

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Potential triggers for sentiment-driven market moves this week1:

  • US: Thursday’s interest rate decision by the Fed (no change expected) and Friday’s Jobs report. Q3 earnings from Apple, McDonald’s Corp, AMD, Starbucks, Airbnb, Amgen, Caterpillar, Qualcomm, Eli Lilly, and Pfizer.
  • Europe: Eurozone GDP and inflation data.
  • APAC: Manufacturing PMI data in China and BOJ’s interest rate decision in Japan.  
  • Global: Sentiment will continue to be heavily influenced by developments in the Israel-Hamas war and the risk of escalation, into a regional conflict.

Insights from last week’s changes in investor sentiment:

Investor sentiment remains bearish in seven out of ten markets we follow, falling to new year-to-date lows in Asia ex-Japan, Global Developed markets, and the US. Elsewhere, UK investors managed to hold on to a neutral stance but with a growing negative tilt, Australian investors turned negative but not yet bearish, and Chinese investors grew bullish, for the first time since late August, on early signs that their economy may have bottomed out. As mentioned before, bearish investors tend to see the glass as always half empty, forcing them to focus on the negatives of rapidly rising (US) bond yields and a deteriorating geopolitical landscape, instead of the so far, better than expected Q32 earnings, from (US) companies.

If Wall Street was a comic book – and it sort of is – then the Magnificent Seven (US big tech) would be its Avengers and last week’s market action would be Part One of its Infinity War (reminder: it ends with the Avengers losing, and most of them withering away into dust). Investors had low expectations for earning growth going into this reporting season, except when it came to those seven companies, and have let their disappointment be known in no uncertain terms (Google-parent Alphabet tumbled almost 10%, shedding more than $166 billion in market value, its biggest one-day loss ever).

In the short term, a bearish sentiment is redefining ‘ESG’ for investors, with a focus on the Economy, Security, and Geopolitics. The economy seems fine and not in need of rescue. No one seems worried about the lack of Russian oil on the market ahead of winter. And the Israel-Hamas war remains confined to Gaza for now. Of the three, the third is of the most immediate concern for investors.

No matter the source of their fears, keep in mind that the ROOF Scores are computed from observed investor preferences. We know they are bearish because we ‘see’ them sell out of risky assets and buy defensive ones. Fear, like high school, is a transient state, one that investors are expected to eventually graduate from or drop out of. Once the danger is past, or risky assets have been disposed of (which ever comes first), the worst behavior we can ‘see’ is investors sitting on the side lines (i.e., low volumes).

Think of the stock market not as a place where investors exchange stocks, but where they exchange risk. Right now, risk is being exchanged at a sharp discount because there are more sellers (risk-averse investors) than buyers (risk-tolerant investors), meaning that many more investors still take the view that risk is expensive rather than cheap.

This ‘riskonomics’ will continue until risk is adequately priced, or news comes out to defuse one of the newly defined ‘ESG’ fears, trimming the ranks of risk-averse investors and bringing some of the dropouts back in, as risk-tolerant investors. Note that negative news could equally confirm one of the ‘ESG’ triggers and delay graduation for the remaining risk-averse investors, forcing them to require an even bigger discount for risk assets, for longer.

Investing often boils down to an exercise of accurately forecasting the supply and demand for risk, neither of which are static. It is fully accepted that risk can be deemed expensive one week and cheap the next, without anyone on Wall Street accusing investors of being hypocrites afterwards.  Still, given the situation in the Middle East, the decline in the average traded volume indicates that bearish investors are increasingly opting for a leap year, before going on to university.

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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Developed markets:

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Developed markets ex-US:

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Emerging markets:

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

2 First meeting at which the CME’s FedWatch predicts a higher probability of a cut (36.8%) than the probability of no change (33%).

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