To The Moon

Insights from last week's changes in investor sentiment:

Last week, investor sentiment turned bearish in Asia ex-Japan and Global Emerging markets. Meanwhile, sentiment stayed negative in Europe and Global Developed markets as investors reassessed the impact of potential tariffs from the Trump administration on those economies. Positive macroeconomic data in Australia (inflation) and China (growth) kept sentiment positive in these markets, while investors in the US, UK, and Global Developed ex-US markets remained neutral.

The risks to sentiment in the near-term include US monetary policy (FOMC meeting on December 18), further tariff threats to global trade from the Trump administration (any Tweets now), and the (very) high degree of concentration risk (Magnificent-7) and overvaluation (S&P 500 Shiller CAPE Ratio is at a current level of 35.23) in US equities.

US Monetary Policy: Last week’s FOMC minutes revealed that Federal Reserve officials were optimistic about declining inflation and a strong labor market, hinting at the possibility of additional interest rate cuts, albeit cautiously. They cautioned against premature rate reductions. Notably, the meeting did not address the economic impact of Donald Trump’s recent presidential election victory but stressed the need for flexibility. In essence, the FOMC minutes were specific enough to make investors anxious, leading them to lower their expectations for another 25bps rate cut at the December meeting from 82% a month ago to 66% now, but vague enough for the Fed Chair to be able to deny wanting to have done so during his upcoming speech this Thursday.

Classic Powell.

Trump tariff threats: In a Trump administration, loyalty trumps ideology, making his decisions unpredictable based solely on ideological grounds. When Trump decides it’s time to strike a deal, he expects full support from those around him, and anyone obstructing this will likely face consequences similar to those experienced by many of his first-term cabinet members. Foreign policy is equally unpredictable in a transactional administration, where any world leader can privately negotiate a deal and potentially reverse policies. This new diplomatic approach was evidenced last week when Trump and Mexico’s President Sheinbaum had “productive conversations on cross-border flows”, resulting in a slight easing of tariff concerns. A meeting with Canada’s PM Trudeau was next.

The ongoing threat of tit-for-tat tariffs and their associated impact on both inflation and global growth has got investors feeling like Al Pacino in the Godfather III – “Just when I thought that I was out, they pull me back in”.

Concentration risk: Until January 21st, markets will sway to the sound of Donald Trump’s Tweets (sorry Elon), making investors feel trapped in an M. C. Escher drawing, where stairs that appear to be going up are actually going down, and vice versa[2]. Uncertainty about what comes next (the unknown unknown), will keep investors crowded into the magnificent seven (the known unknown), adding to the already high degree of concentration risk in the market.

The “magnificent seven” – that’s not a lot. It’s not just not a lot of magnificence for a blue chip index to have, but it’s not a lot of companies to be considered magnificent in one index. It makes you think about how fragile the rest of the index must be to not even be considered.

[2] Ascending and Descending - Wikipedia

Potential triggers for sentiment-driven market moves this week[1]

• US: Fed Chair Powell speech, manufacturing & services PMI data, consumer sentiment index, and the November jobs report.

• Europe: Eurozone unemployment and retail sales data. Germany’s factory orders data and France’s manufacturing production numbers.

• APAC: China PMI data. Speeches from BoJ officials in Japan. Australia’s Q3 GDP data.

• Global: The wars in Ukraine and the middle east remain in their most dangerous phase yet ahead of January 20th.

 [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.

[2] Ascending and Descending - Wikipedia