To The Moon

Over the past two weeks, investor sentiment weakened across most major markets except China, where it remained consistently negative, and the United States, where it held steady at neutral. Sentiment in Japan dipped slightly ahead of the snap elections, though the ruling coalition’s subsequent supermajority win should give Takaichi ample room to pursue her “proactive fiscal policy,” a likely positive for equities but less so for bonds. Is Canada next with a snap election (@Carney)? Meanwhile, geopolitical tensions involving Iran and renewed concerns about AI’s economic impact continue to restrain sentiment despite stronger‑than‑expected earnings so far (with 54% reported), which helped lift the Dow Jones Industrial Average above 50,000 for the first time in its 129‑year history.

Investors have long stopped believing that Lady Luck is a kindly old lady who hands out good fortune like sweets at a county fair. She’s more like the host of a celestial hidden camera show, using markets - and the emotional whiplash they inflict on investors - as the showcase she uses to amuse the other gods. On the ‘predictables’ – earnings - investors have been less positive than they should have been with 76% of companies that have reported so far beating investors’ estimates according to Factset. On the ‘unpredictables’ – the economic impact of AI - they have been more positive than perhaps they should have been, thinking AI was the tide that lifts all boats without sinking any of them.

Markets fell on Thursday last week in yet another bout of AI‑induced panic, with the Anthropic news stinging investors like a slap on sunburnt skin - something about AI making legacy software firms look not quite like a billion dollars but only twenty-three or twenty-four of them, give or take a few bucks – “They’re software has-beens, not worth the market-cap they take up in the index, it’s a mercy killing, the humane thing to do”, that kind of thing.

Then on Friday, investors had a Saint-Paul-on-the-road-to-Damascus style revelation, suddenly deciding clearly what side their bread was buttered on, and like a video of a dynamited tower block played in reverse, markets snapped back up – Brave Investors Stay Loyal to AI Amid Market’s Misinformed and Cruel Markdown, that kind of thing.

When it comes to AI news, investors’ nerves are raw, exposed, on the outside. AI is the Pompidou Centre of their central nervous system - every fragile wire and trembling pipe displayed on the façade for all to poke at. It’s hard to pinpoint why investors changed their minds on Thursday night, because conviction and loyalty don’t wake you up in the middle of the night and run Daytona 500 rings in your head, the way second thoughts and mutiny do. But at some point during the night, investors decided to shed their doubt and jump back into AI – “Come on, get off the cross! They need the wood”, that kind of thing.

Geopolitics is the other weight pulling down investor sentiment. After Venezuela, the US now finds itself in a face‑off with Iran that threatens once again to set the Middle East alight. Fresh from recent “successes,” investors seem to be hoping that, once the bombing starts, the regime in Tehran - like the one in Caracas - will accept a deal with the same gratitude that a drowning victim might accept a rope.

The other geopolitical item on the calendar is this weekend’s Munich Security Conference (Feb 13–15)—an event investors will remember all too well from last year’s proceedings. Yet despite these headwinds, and the occasional burst of domestic political theatre, the underlying economy and corporate earnings continue to paint a far more reassuring picture than investors had expected. For now, that combination still supports today’s elevated valuations and has even emboldened investors to wander into some of the market’s less‑traveled sectors. The music, it seems, is still playing, so investors keep dancing, but, as last Thursday revealed, everyone knows that when it stops, there won’t be nearly enough chairs to go around.

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

• US: (delayed) US jobs report and CPI data, retail sales, and employment cost data.

• Europe: UK Q4 GDP data, industrial production, and trade data. Wholesale sales in Germany, final inflation figures in Spain, and the unemployment rate in France.

• APAC: Japan snap election results, nominal wage growth, current account balance, producer prices, and machine tool orders. China CPI data.

• Global: Ongoing tensions in the Middle East (Iran), and peace negotiations in 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 ten 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 ‘emotionally’ 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.