To The Moon

Last week, sentiment improved in the US and, by extension, in Global Developed Markets, as well as in China and, consequently, in Global Emerging Markets. Conversely, sentiment declined in the UK and Australia. Investors remained bullish in Japan, neutral in Europe, slightly more positive in Global Developed ex-US markets, and bearish in Asia ex-Japan.

China: The macroeconomic outlook continues to deteriorate, with deflation risks rising further in November. New loans extended by China’s banks fell significantly short of expectations, amounting to less than half of last year’s levels, indicating persistently weak credit demand. Last week, following the third consecutive meeting since September that promised strong economic stimulus measures, the annual Central Economic Work Conference (CEWC) concluded with authorities once again pledging to “raise the cap on the budget deficit, issue more debt, and loosen monetary policy to maintain a stable economic growth rate of around 5%”, without saying how or, more importantly, how much.

According to the theory of cognitive dissonance, investors who have endured the chaos of Covid lockdowns, two failed reopening attempts, a property market collapse, and three consecutive years of negative market returns are likely to either completely reject the authorities’ promises of better economic days ahead or embrace them fully. Sentiment ended last week bullish – the Stockholm syndrome at work.

The US: This week, the focus will be on the predictable known unknowns of inflation and monetary policy decisions, rather than the unpredictable unknown unknowns surrounding the policies of the incoming Trump administration. With the Fed’s decision to cut interest rates by another 25 basis points almost certain, investors will scrutinize the language of the press release to predict if and when further cuts might occur in 2025, and what the Fed’s trigger points will be.

Europe: The UK’s economy experienced negative growth in Q3, Moody’s downgraded France’s credit rating, Germany remains without a functioning government until new elections are called, and the ECB cut interest rates for the fourth time last week. The absence of market-moving news in the last two weeks of the year is likely to keep investor sentiment neutral and markets directionless. While the ECB’s dovish monetary policy is a positive factor, the negatives of weak domestic politics and the incoming Trump administration’s tariff threats will likely keep both sentiment and markets rangebound, as they have been since late May.

It is safe to say that 2025 will have very little in common with 2024 or 2023. The primary source of risk will shift from monetary policy to trade policies and geopolitics, compelling investors to focus on politicians instead of central bankers for the first time in four years. There is a saying in the art world that if you create something no one hates, no one will love it either, and that’s true. The same applies to policy decisions, trade deals, and politicians. Especially politicians.

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

• US: Fed interest rate decision. Retail sales, PCE prices, personal income and spending, industrial production, manufacturing and services PMIs, building permits, housing starts, and existing home sales data.

• Europe: In the UK, BoE’s interest rate decision, inflation figures, retail sales data, and the jobs report. Moody’s downgrade of France’s credit rating to “Aa3” from “Aa2”. Germany’s Ifo business climate index, and ZEW economic sentiment. Eurozone PMI figures.

• APAC: China industrial production, retail sales, jobless rate, housing prices, and loan prime rates data. Japan’s BoJ's interest rate decision, inflation and foreign trade data.

• Global: Monetary policy decisions across major central banks (US, UK, Japan, China) will be the focus this week. Maybe for the last time.

[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.