The recent rise in sentiment that began in early September (excluding China) paused last week as investors tensely awaited the outcomes of the US Presidential election and the meeting of China’s Standing Committee. The previous week’s bullish mood among investors in Asia ex-Japan, Australia, Global Developed markets, Global Emerging markets, and the UK turned neutral ahead of these events, recognizing the binary nature of these potential outcomes.
The US Election: Last week, the markets were weighed by anxiety about the US election, largely due to predictions of a very tight race by pollsters – the same ones who forecasted “Remain” and “Clinton” back in 2016. The combination of a deeply divided electorate, sharply contrasting visions from the candidates on America’s future, and the expectation of a tight result, sparked fears of potential political violence post-election. This grim outlook kept many investors on the sidelines, holding on for dear life.
Contrary to these fears, democracy emerged victorious last week. Every vote was cast, counted, and trusted, with the results accepted by both sides within 48 hours. This was a best-case scenario for markets. Two-thirds of registered voters felt trapped in a country going down the wrong track, and wanted change (only 28% felt it was on the right track). Last week they delivered a verdict echoing a quote often (wrongly[1]) attributed to the poet Anais Nin: “And the day came when the risk to remain tight in a bud was more painful than the risk it took to blossom.”
America woke up on the next day with a new-ish President, and a victory for democracy over anarchy. The anxiety relief was immediate, and in a sign of how good investors felt letting go of holding on, the S&P500 experienced a 2-standard deviation rally the very next day[2]. The only cost was the second missed opportunity for a historic first woman President, which slipped away once more, becoming a memory we’ll never have, from a time we can’t get back.
China Stimulus: China’s economy is now in its fourth year of a slowdown, which authorities only began to acknowledge last August. The crisis of confidence among businesses and consumers, driven by collapsing real estate and stock markets, continues to fuel persistent deflationary pressures. Over the weekend, hopes for a substantial stimulus package were partially met with the announcement of a 10 trillion Yuan ($1.4 trillion) debt swap program for local governments over the next five years, which should be enough to stabilize markets. However, the absence of additional fiscal stimulus measures to recapitalize banks and spur consumption will leave investors wanting more. The irony for the CCP leadership is that while it likes to blame unfettered capitalism for various issues, China’s only viable economic option now may be to become a better capitalist.
For now, the news from the US and China, combined with another round of interest rate cuts by the Fed, the ECB, and the BoE, along with improving retail sales figures across the Eurozone, should be sufficient to maintain market momentum for the rest of the year. Investors are also aware that in a Trump-led world, the quickest way to incur losses is to guess, speculate, or assume to know his next move. Therefore, for the time being, investors will likely enjoy the potential gains of having a business-friendly President and Congress, while postponing concerns about domestic political impacts and international geopolitical effects of a Trump 2.0 until next year.
Potential triggers for sentiment-driven market moves this week[1]
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US: CPI, PPI, retail sales data, and speeches from several Fed officials. Earnings from Home Depot, Cisco Systems, Walt Disney, and Applied Materials.
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Europe: .
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APAC: China new yuan loans, fixed asset investment, industrial production, retail sales, and the house price index, and details of the 10 trillion Yuan Stimulus package. Japan Q3 GDP and current account data, and the BoJ’s Summary of Economic Opinions.
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Global: The focus this week will return to economic fundamentals and whether both inflation and interest rates are still on their way down.
[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:
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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.
[1] The original author of the quote is Lacey Bennett, a publicist for an adult education college in California.
[2] The Vix closed at 20.5% on November 5th, corresponding to a predicted +/- 1.28% daily move. The S&P500 rose by 2.53% on November 6th, corresponding to a 1.98x the predicted range.
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