Investor sentiment remains weak across global markets, ending the week bearish in five out of the ten markets we track and negative in three others. While sentiment has bottomed out in some regions (including Global Developed Markets, Global Developed ex-US Markets, Europe, Japan, the UK, and the US), it continues to deteriorate in others (such as Asia ex-Japan and Global Emerging Markets). Sentiment held steady only in China and Australia, where investors stayed neutral and positive, respectively.
The current negative supply-demand imbalance for risk in several markets, as indicated in the Risk Tolerance and Risk Aversion charts below, makes them susceptible to sharp downside moves, particularly in response to any negative interpretations of upcoming Fed speeches or hints of delays in coordinated central bank pivots at the Jackson Hole Symposium this weekend. In summary, several key markets are poised for an emotional overreaction, but a catalyst is needed to turn this cognitive bias into decisive action (i.e., selling). Absent an actual reason to sell, risk aversion remains just a bias.
Monetary Policy: Currently, US investors are fully certain of a 25 bps rate cut in September, with a 40% chance it could be doubled to 50 bps. Looking ahead, they anticipate 8 additional 25 bps cuts next year, bringing the Fed Funds rate to the 3.25–3.50% range by the end of 2025. However, despite this optimistic outlook, bearish investor sentiment means a single data point, like a strong jobs or inflation report, or hints of a recalcitrant Fed, could rapidly turn their brown eyes blue.
Geopolitics: Peace efforts in both Gaza and Ukraine face ongoing challenges rooted in a lack of trust - neither side can fully rely on a U.S. commitment to the peace process without knowing who will be in the White House next year. As a result, geopolitical risks will continue to simmer, with the potential to escalate, especially if Iran or Hezbollah deliver the strong responses still anticipated. However, unless a regional war breaks out, geopolitics currently takes a back seat to monetary policy as the primary market driver.
Local Politics: The Democratic National Convention in Chicago is set to dominate the news this week. While the nomination outcome is expected to be straightforward, VP Kamala Harris will outline more of her vision for leading the country, aiming to capitalize on the convention momentum to further boost her lead in the polls. Meanwhile, Donald Trump has reverted to the mean (literally), launching personal attacks against his opponent, even claiming “I am better looking than she is” – honestly I don’t know why the country music people aren’t’ all over this one. Watch for security risks during the convention as a potential sentiment trigger, though it would likely need to coincide with one of the previously mentioned factors to have a significant impact.
Others: The ongoing absence of a credible stimulus package from Chinese authorities in response to the looming economic slowdown will likely keep sentiment depressed in China, Asia ex-Japan, and Global Emerging Markets, though the impact should remain contained within those regions. In Japan, the risk of further unwinding the carry trade has been temporarily avoided, even reversed, following the BoJ’s unexpected lip service away from imminent quantitative tightening. However, sentiment continues to be exposed to expectations of lower interest rates in the US and the need for tighter monetary policy in Japan, which will keeps the carry trade at significant risk.
For the remainder of the year, growing uncertainty around these issues will intensify investors' focus on the balance between risk and return, particularly as they seek to safeguard their year-to-date performance. Risk and return are inherently linked and functionally complementary: the Cain of risk against the Abel of return. Will the rest of 2024 unfold like a biblical tale?
Potential triggers for sentiment-driven market moves this week
US: FOMC minutes and speeches by several Fed officials ahead of the Jackson Hole Symposium over the weekend. Manufacturing and Services PMI, and new home sales data.
Europe: ECB monetary policy meeting minutes, Manufacturing and services PMI, and consumer confidence data for the Eurozone and the UK. Bank of England governor speech.
APAC: Japan machinery orders, trade balance, and manufacturing and services PMI data. Loan prime rate setting by the BoC in China.
Global: Indications of a persistent hawkish stance in Federal Reserve speeches, the nature and magnitude of Iran's eventual response, security concerns arising from the Democratic National Convention in the US, and any ongoing silence from Chinese authorities regarding further stimulus measures.
Note: green background = bullish, red background = bearish
Changes to investor sentiment over the past 180 days for the markets we follow:
How to Interpret These Charts:
Top Charts:
The top charts illustrate the ROOF ratio, which represents investor sentiment. This ratio is depicted in green on the left axis, while the cumulative returns of the underlying market are shown in black on the right axis. Key reference lines include:
A horizontal red line at -0.5 (left axis), marking the threshold between negative sentiment (-0.2 to -0.5) and bearish sentiment (< -0.5).
A horizontal blue line at +0.5 (left axis), indicating the boundary between positive sentiment (+0.2 to +0.5) and bullish sentiment (> +0.5).
A horizontal grey line at 0.0 (left axis), around which sentiment is considered neutral (-0.2 to +0.2).
Bottom Charts:
The bottom charts display the levels of risk tolerance (green line) and risk aversion (red line) within the market, representing investors' demand and supply for risk, respectively. Key insights include:
When risk tolerance (green line) exceeds risk aversion (red line), more investors are willing to buy risk assets than there are investors willing to sell them at the current price. This scenario forces risk-tolerant investors to offer a premium to entice more risk-averse investors to trade, thereby driving markets upward.
Conversely, when risk aversion (red line) surpasses risk tolerance (green line), the market dynamics reverse.
The net balance between risk tolerance and risk aversion levels is used to compute the ROOF ratio shown in the top charts, reflecting the sentiment of the average investor in the market.
Blue Shaded Zone:
The blue shaded zone between levels 3 and 4 for both indicators signifies a reasonable balance between the supply and demand for risk in the market. When both lines remain within this blue zone, the market is considered stable. However, when both lines move outside this zone, the significant imbalance in demand and supply for risk can lead to overreactions to unexpected news or risk events.
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