Investor sentiment remained stable last week, with notable exceptions in Asia ex-Japan and Europe, where the outlook shifted slightly from bearish to negative. In Global Emerging Markets, sentiment improved from negative to neutral, while in Japan, the weakening Yen contributed to a positive mood among investors. Chinese investors have once again become hopeful on talks of yet another stimulus package. However, the disparity between potential supply and demand for risk continues to be quite negative in Global Developed Markets, Global Developed ex-US Markets, and Europe, making these markets susceptible to overreactions in case of any negative developments.
Over the past two weeks, the Fed, ECB, BoE, and BoJ all made interest rate decisions that aligned with investors’ expectations, helping to keep sentiment stable by avoiding major (monetary policy) surprises. However, each central bank still has two rate-setting meetings left this year, where they could catch unsuspecting investors off guard, as if markets somehow consisted, again and again, of Charlie Browns running to kick Lucy’s football.
Meanwhile, US investors are trying to stay focused on the direction of interest rates and the economy, but the penetrating noise of the Presidential campaign needles itself into conversations, pocking at their confidence and restraining sentiment. Right now, the buzz revolves around the likelihood of a second debate between Donald Trump and Kamala Harris. Never mind that watching them ranks near the bottom on the scale of most voter’s favorite pastimes—somewhere below peeling a potato, not far above flossing.
On a global scale, economic fundamentals are favorable for equities—there’s a soft landing in the US, anaemic growth in Europe (but no hard landing), the BoJ is finally addressing inflation in Japan, and interest rates are trending downward. However, investors remain concerned about domestic politics in France, Germany, and the upcoming US election. Additionally, geopolitical tensions from the escalating conflicts in Ukraine and the Middle East add to the uncertainty.
This environment is likely to keep markets and sentiment confined within a narrow range until the Q3 earnings season kicks off and investors hear directly from CEOs about the strength of consumer spending. Earnings reports are written primarily as an ethnographic recording, as if the point of reading them were not to go fishing but to admire somebody else’s catch. At current lofty valuations, CEOs had better be showcasing a monster fish.
Potential triggers for sentiment-driven market moves this week[1]
US: Personal Consumption Expenditures (PCE), personal income and spending data. Speeches from several Fed officials, Q2 GDP growth (final estimate), consumer confidence, durable goods orders, and manufacturing PMI data.
Europe: Eurozone manufacturing PMI and business sentiment data. German unemployment data, and Swiss National Bank’s interest rate decision.
APAC: YTD Chinese companies’ industrial profits. In Japan, manufacturing PMI data and minutes from the BoJ’s rate setting meeting. Australia’s RBA interest rate decision meeting.
Global: Escalating tensions in the Middle East and Ukraine.
[1] If sentiment is bearish/bullish, a negative/positive surprise on these data releases could trigger an overreaction.
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.
[1] If sentiment is bearish/bullish, a negative/positive surprise on these data releases could trigger an overreaction.
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