Investor sentiment saw a boost last week, with six out of the ten markets we track (Asia ex-Japan, Australia, Global Developed, Global Developed ex-US, Global Emerging, and the UK) closing the week on a bullish note. Japan’s sentiment was also positively influenced by a weakening Yen, nearly reaching bullish levels. In Europe, investors briefly turned bullish but ended the week with a neutral outlook. Meanwhile, sentiment in the US and China remained cautious due to upcoming significant events in these markets: the US elections and China’s Standing Committee meeting. Why are global investors so convinced (bullish) of a good outcome when local investors (US and China) are themselves unsure?
The US Election: Investors globally have been increasingly positioning their portfolios for a Trump victory. This week, they will find out if they were right. But what if they were wrong? Another way to ask this last question is, would a Harris win be that bad for markets, or is it just a stock selection issue?
Investors do not like uncertainty. Recently the momentum in the presidential race has been with Trump and the betting markets seem convinced he will win, so sentiment and markets rose on that newfound clarity. It seems that for now, investors have chosen to take Trump’s campaign promises seriously, but not literally. This consensus, however, makes a Harris win the underpriced scenario which could trigger a big market reaction. Especially if the election results in a divided government with a Harris White House and a Republican House. This is the scenario with the biggest downside risk for both markets and the economy, and it has not been priced in.
America is deeply divided, and the current level of discontentment makes political violence or disillusionment a real possibility, if not a probability. A narrow Harris victory could heighten the risk of civil unrest. The rise of the VIX index, alongside the improving odds of a Trump victory in the betting markets since late September, suggests that investors are increasingly willing to pay a premium to protect themselves from this underpriced scenario. However, the current VIX level of just around 20% indicates that they have only assigned it a low probability. This week, that probability will either drop to zero, or surge to 100%.
China’s Stimulus: Another major risk event on investors' radar this week is the week-long meeting of the Standing Committee of the National People’s Congress. After acknowledging the severity of the economic challenges in late August, authorities have announced a series of planned monetary and fiscal stimuli aimed at stabilizing the real estate market, preventing a Lehman-like crisis, and returning the economy to a sustainable growth path. However, the lack of detailed information, particularly regarding the size of the planned stimulus, has led to growing anticipation for a substantial figure. Investors are anxiously awaiting the final announcement from this meeting, as anything short of expectations could lead to significant market disappointment.
US-China Relations: Since the 2016 US elections, global investors have been concerned about the potential for the US and China to become fierce adversaries, possibly igniting a new Cold War. This week, however, the focus will shift to whether both nations can survive their self-inflicted wounds. With the US at war with itself, the question is: can democracy survive post-election? Meanwhile, as China's economy faces a prolonged structural slowdown, can its government enact the necessary reforms to avert a lost decade? In short, this week is less about whether the US and China will try to destroy each other, and more about whether, instead, they will take their own lives.
Think of the stock market as a place where investors are given safety and sanctuary, but at a cost. Every trade, every bet, has a price, sometimes a hefty one. The speculation is literal. The potential drawdowns are metaphorical. It is a place where investors alternate between keeping their cool and losing their cool. What will it be this week when the stakes are so high?
Potential triggers for sentiment-driven market moves this week
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US: Presidential elections and the Fed’s interest rate decision. Services PMI, consumer sentiment, and non-farm productivity data. Ongoing earnings releases for selected mid-caps.
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Europe: BoE’s interest rate decision in the UK. Germany's industrial production, factory orders, and trade balance data. Eurozone retail sales data.
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APAC: China’s Standing Committee of the National People’s Congress meeting and details on the size of the fiscal stimulus and restructuring that were previously pledged. Japan’s Tankan survey and BoJ’s minutes from last week’s interest rate setting meeting. Australia’s RBA interest rate setting meeting.
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Global: The US elections will take center stage for global investors this week. Second will be the outcome of China’s SC meeting. Third, any retaliations by Iran on Israel.
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:
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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).
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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).
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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:
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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.
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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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