While the US market has hit multiple record highs in 2021, investor sentiment thus far has been more negative than positive. Of the 135 trading days from January 4 to July 21, 2021, our ROOF Ratios indicated that investors were bullish on only seven days, bearish on 36 days, and uncertain about the future direction of markets on the remaining 92 days (see chart below). And although the market has been strong, the more risk-averse sectors have led the way.
In this chart, the black line represents the cumulative return for the STOXX® USA 500 index. The green line is the cumulative return of our Risk-Off portfolio and the blue line for our Risk-On portfolio (all three are measured against the right axis). These are constructed using our Sector ROOF Scores, which track the ROOF personalities of sectors (i.e., are they risk-averse or risk-tolerant sectors), as well as the preference of investors for each type of sector. The orange bars represent the daily ROOF ratios for the US market (measured against the left axis). When these bars drop below the flat red line, investors are said to be bearish, and when they rise above the flat green line, they are said to be bullish. Between those two flat lines, investors are more neutral, with their level of uncertainty varying from cautious optimism when the bars are above 0 (but below the flat green line) to increasing skepticism when they are below 0 (but above the flat red line).
Year-to-date, the STOXX USA 500 index is up 16.1%, while the Risk-Off portfolio is up by 17.7%, and the Risk-On portfolio is up ‘only’ 11.4%. The Risk-Off portfolio’s outperformance is also in line with the Volatility factor’s underperformance since early February. So, while markets have hit continual record highs, they have done so on the back of cautious and skeptical investor sentiment.
That said, since the start of Q2 2021, the dominance of the Risk-Off portfolio (green line) has been more mixed, with the Risk-On portfolio (blue line) outperforming for short bouts and the two trading places twice during this short period.
Are we at a turning point for investor sentiment?
The recent trend in our US ROOF Ratio (orange bars in the chart above) points to further weakness in sentiment in the short term, although investors are not showing signs of becoming bearish yet, just more skeptical about what to make of the ongoing debate over rising inflationary pressures and economic growth. The (highly) positive earnings season so far should be supportive for positive sentiment, but we have yet to see this being reflected in how investors position their portfolios. As of July 21, 2021, all three portfolios (Index, Risk-On, and Risk-Off) are too close to indicate a trend in either direction. This convergence is in line with investor sentiment (as represented by the ROOF Ratio – orange bars in the chart) being neutral, with the supply and demand for risk at equilibrium.
Q2 2021 may end up being a turning point for sentiment, but as of July 21, the direction of sentiment remains as uncertain as the current level of sentiment itself.
On the one hand, it seems to investors that all the good news has been priced into current valuation levels; that inflation is stronger than we thought and may last longer, too; that COVID-19 variants are still affecting local economies and global supply chains; and that geopolitical risk is rearing its ugly head once again. On the other hand, governments and central banks remain in an ultra-accommodative mood that limits the downside, especially for equities, since there isn’t much competition for returns from the other asset classes. Bottomline, we may remain in this complicated state for a while, with investors feeling like almost anything could happen—which is, one might say, the essence of uncertainty.
 A negative performance of the Volatility factors means that Low Volatility names outperformed High Volatility ones (everything else being equal).