ROOF Highlights — October 5, 2020

Qontigo ROOF™ Score Highlights: Week of October 5, 2020

Potential triggers this week: Covid-19 developments including the health of President Trump after testing positive for the virus last Friday. The VP debate between Pence and Harris on Wednesday night, as well as minutes from the Fed and ECB meetings. On the economic data front, US Non-Manufacturing PMI and foreign trade, UK monthly GDP, Eurozone retail sales, Japan current account, Australia business morale and worldwide services PMI surveys. The Q3 earning season also gets underway this week.

Summary: Investor sentiment declined this past week for all markets we track except the UK. Increasingly negative narrative on the resurgence of new Covid-19 infections across Europe and the US, culminating last Friday with the news that President Trump himself tested positive, weighed on sentiment. Despite these developments, those countries with the highest rate of new infections – the US, UK, and Developed Europe –  remain cautiously optimistic with ROOF Ratios in the upper range of neutral or bottom range of bullish zones, indicating that investors there still fully expect further fiscal stimulus to be released.  For the next month, CEOs will be adding their voice to those of politicians and central bankers as the Q3 earnings seasons get underway. This will be investor’s first chance to quantify what a US economy without fiscal stimulus means for earnings.

US Investor sentiment fails to achieve lift-off without stimulus.

Both variants of the US ROOF Ratio failed to breakout of the neutral zone last week (top chart). Uncertainty as to the outcome of the upcoming election for both the Presidency and the Senate, as well as the timing and eventual size of a second fiscal stimulus package is keeping investors on the edge. The Q3 earnings season is about to start and some are hoping that CEOs can bring some clarity on the impact of a lack of stimulus on earnings (i.e. worst case, can the economic recovery stand on its own?).

The supply and demand for risk is almost balanced now and a long way from the positive gap we saw in July and August that powered the markets higher during the summer (bottom chart). Since the start of September, sentiment has returned to the neutral zone and markets have been correspondingly directionless. It remains to be seen if CEOs can inspire investors in a way the first Presidential debates has not. Clarity on the impact of the lack of stimulus since July 31st on earnings will inform investors as to the size of the fiscal stimulus response they can expect (i.e. the bigger the impact, the larger the stimulus package and the sooner it will come).

Sentiment in Developed Europe remains willing, but the news cycle isn’t cooperating.

Rising new infections in key markets and growing talks of social distancing guidelines as well as border closures is unnerving investors.  Both of our ROOF variants declined sharply last week and seem headed for the neutral zone (top chart). European investors have been bullish for over 117 consecutive days now but the STOXX Europe 600 is still down about 11% YTD.

Despite a gradually declining demand and supply balance for risk since mid-July, risk tolerance has remained higher than risk aversion since May (bottom chart).  This positive cognitive bias, however, was not met with any positive macro news to turn a strong risk appetite into an over-reaction to the upside.  The economic recovery has been anemic, the post Brexit trade relations between the UK and the EU remains undefined, and several countries are experiencing a bigger second wave of new infections than their first which toppled markets back in March. Continued negative news will prevent this positive balance in favor of risk tolerance from being triggered and, if it continues to weaken, sentiment will fall back into the Neutral zone, where negative news is not so easily ignored.

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

Global Investor’s risk appetite remained neutral for the third week in a row (top chart).  The strong rise in risk tolerance since early March and the corresponding decline in risk aversion had powered a strong market recovery but risk appetite stalled in mid-August and reversed to a neutral position by early September, bringing the market’s recovery to a halt since then.

Conversely, investors in Asia remained bullish, with the balance between risk tolerance and risk aversion clearly in favor of the former (bottom chart). This strong risk appetite, however, was not given any positive triggers this past months and still hangs on the hope for a new stimulus package in the US and Europe to help jumpstart the global economy.  The drop in risk aversion also seems to point to a lower concern with regards to the US presidential election and the possibility of renewed trade tensions between the US and China. Still, free(-er) of negative Covid-19 narrative than its regional peers, risk appetite remains strong in the Asia ex-Japan, but it will take a trigger in the form of actual good news to turn it into action.  Failing that, sentiment may remain bullish, but markets are not going anywhere.