Qontigo ROOF™ Score Highlights: Week of June 19, 2023

Author: Olivier d'Assier, Qontigo

Potential triggers for sentiment-driven market moves this week1:

• US: Focus will be on speeches by several Fed officials, including Chair Jerome Powell’s testimony before Congress. On the macro side, services and manufacturing PMI data.

• Europe: Bank of England interest rate decision; UK May inflation, retail sales and consumer confidence. Eurozone, France, Germany and UK PMI data.

• APAC: Japan inflation; PMI data for Japan and Australia.

• Global: The lack of synchronization across major economies and the ongoing hawkishness of central banks is keeping uncertainty levels elevated. The counteroffensives underway in Ukraine could also present a geopolitical roadblock to the recent market rally.

Insights from last week’s changes in investor sentiment:

Investor sentiment and markets agreed to disagree last week, ending in a state of divergence in all countries we follow except in the UK. This deviation between markets and sentiment, together with the ongoing lack of trading volume, suggests investors remain two parts loner and one part joiner when it comes to this rally, and maintain a healthy suspicion that there’s always a dark side of nice. In Japan, the surge in volume since May reflects the arrival of hordes of foreign investors, on a break from the rude hand of regulatory intervention at home, who decided it was okay to start seeing other markets. In China, the economy didn’t get the rise regulators expected from all the revenge spending post-COVID reopening which continues to weigh on sentiment despite the market rally.

In the US, the Federal Reserve stayed its hand on an eleventh consecutive rate hike but raised its forecast for GDP growth (1.0% vs. 0.4% previously), projected lower unemployment rate (4.1% vs. 4.5% previously) and higher core PCE inflation (3.9% vs. 3.6%) for the rest of the year. This puts a big dent in the hopes and expectations of the pivoteers, who had imagined a slowing economy, and, as long as we’re dreaming, impeccable logic, that the Fed would throw inflationary caution to the wind and begin a new round of quantitative easing. That fishing expedition worked in August last year, and again in January this year, lifting both markets and sentiment each time, but alas for the pivot faithful, this hook seems to have lost its worm.

In Europe, the ECB was widely expected to raise interest rates at its June meeting, but investors hoped for a signal that it would follow the Fed’s decision to pause and give the economy a chance to catch up to the lagging effect of monetary policy. Instead, the ECB reaffirmed its commitment to raise rates again at its July meeting, stating that although the economy has spoken about the pain from the previous seven rate hikes, that voice sounded more like a mild protest than a low strangled cry of pain. Risk-tolerant investors will now have to adjust to the fact that there will be other tolls along the road to monetary easing.

Globally, markets seem to be shrugging off central banks’ assertions that more monetary tightening is coming, but there are signs (low volume, lack of breadth, declining sentiment, defensive styles outperforming cyclical ones, etc.) that this rally is powered by skepticism rather than confidence. Investors have yet to be given a reason to jump back in with both feet and instead are just tiptoeing along in the most recession-proof segment of the market they can find (big tech in the US, luxury goods in Europe), and it’s getting increasingly crowded on that ‘RAM and Glam’ strip.

Please refer to Qontigo’s ROOF™ Score Methodology for the ROOF™ Score Table calculation: https://qontigo.com/introducing-axiomas-roof-score-methodology/

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). In between those two lines, 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.

Asia ex-Japan:

Australia:

China:

Developed markets:

Developed markets ex-US:

Emerging markets:

Europe:

Japan:

UK:

US:

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