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Potential triggers for sentiment-driven market moves this week1:
- US: Federal Reserve’s interest rate decision and the Jobs report. Biggest week for earnings (106), with five of the Magnificent Seven reporting.
- Europe: Bank of England’s monetary policy decision and Q4 GDP growth rates for the Euro Area, France, Spain, Germany, and Italy. Inflation figures for Spain, and unemployment for Euro Area.
- APAC: China manufacturing PMI data and the BoJ’s minutes on monetary policy.
- Global: Any sign of further escalation in the Middle East conflict after this weekend’s drone attack on US forces in Jordan. Investors will await the US response, that President Biden says is coming.
Insights from last week’s changes in investor sentiment:
Sentiment declined globally in the past two weeks as investors face an increasingly negative geopolitical world that really burns their toast. Sentiment had risen since November last year on the belief that both the Fed and the ECB would start to cut interest rates as early as this March. The mood reversal of the past two weeks indicates that most of them now acknowledge that this was less of theory and more of a guess. They have now set the May FOMC meeting as the absolute bar-is-closing, last call time limit for a rate cut. Global Developed ex-US investors have retained their bullish hopes, despite weak economic data out of Germany in the prior week. Their thinking seems to be that if the US can avoid a recession, so can the rest of the (developed) world, even though that is 100 percent not grounded in reality as most of the time in the past 20 years, the opposite was true.
Several geopolitical risks will continue to weigh on investor sentiment. In 2023 investors were looking for relief from inflation. In 2024, they are looking for relief from high interest rates in the form of numerous rate cuts. Yet, geopolitics is making it hard for them to reach the level of confidence it would take to chase markets higher from here (historical high in the US). Instead, investors display that same nervous, fidgety feeling that dogs get when hopping in the car to go to the vet. They know they’re not going to the park.
The US at war with itself: The US looks like it is heading for a (divisive) Biden-Trump rematch this November. Joe Biden, whose approval ratings peg him as the kind of person you would expect to be eaten first in any Lifeboat situation, should clinch his party’s nomination, not unchallenged, but unencumbered. Meanwhile Donald Trump, is steamrolling through the Republican primary process, emerging as the GOP’s McDreamy. Trump is benefiting from a feeling that life hasn’t gotten better or easier for most voters under Biden and troubles that had been an ignorable little dripping faucet in 2020, have turned into a waterfall of struggles in 2024, unleashing a tidal wave of angry votes. The increase in partisan politics this rematch comes with has already made the 118th Congress the most unproductive in modern history and its ineffectiveness and perceived inability to respond quickly and decisively to any crises, will continue to weigh on investor sentiment.
China stalling: Round five of the China Bailout Roulette started last week. Rumors that a bureaucratic White Knight, who needed to be pried out of his Superman costume as a child, will swoop down from the sky and rescue the economy from the Slough of Despond, carry its limp form to the shore, and resuscitate it with the mother of all monetary and fiscal stimulus, (temporarily?) lifted markets just as sentiment turned bearish. Beyond a large cut in the reserve ratio, however, the authorities, in a “you-don’t-talk-about-fight-club” sort of way, have remained mute about the size and nature of said stimulus.
Israel-Hamas war: This weekend marks the first US military casualties from hostile fire in this war, allegedly at the hand of an Iran-backed military group (The Islamic Resistance) in Iraq. Investors are likely to respond to this escalation in a knee-jerk reaction as fears of a wider Middle East conflict and memories of the impact of higher oil prices on inflation threaten to rewrite the pivot narrative and forces a flight-to-safety.
This week holds significant importance for investor sentiment and future market directions. Geopolitical developments, monetary policy decisions, and Big Tech corporate earnings updates are set to dominate the headlines of major newspapers, each competing for attention and influence. The week’s news flow will aim to redirect investors’ sentiment by reshaping their neural pathways, alternately stimulating the pleasure center of the brain, and triggering a primitive reptilian response.
Pivotal as it may be, the veil of ignorance about the rest of 2024 is unlikely to be completely lifted after this week. Trying to predict the next eleven months (and beyond) based on events from a single week is like trying to predict the weather based on a puddle’s worth of reflected sky. Once the facts are known and data has been collected, new forecasts from fortune tellers (yours truly included) will be written and presented to investors with the dutiful obedience of a cat leaving a dead mouse at your bedroom door. Stay tuned. Onward and awkward.
Changes to investor sentiment over the past 180 days for the markets we follow:
How to read these charts: The top charts show the ROOF ratio (investor sentiment) in green (left axis), against the cumulative returns of the underlying market in black (right axis). The horizontal red line at -0.5 (left axis) represents the frontier between a negative sentiment (-0.2 to -0.5) and a bearish one (<-0.5), and the horizontal blue line at +0.5 (left axis) represents the frontier between a positive sentiment (+0.2 to +0.5) and a bullish one (>+0.5). Around the horizontal grey line at 0.0 (left axis), sentiment can be considered neutral (-0.2 to +0.2).
The bottom charts show the levels of both risk tolerance (green line) and risk aversion (red line) in the market. These represent investors’ demand and supply for risk. When risk tolerance (green line) is higher than risk aversion (red line), there are more investors looking to buy risk assets then investors willing to sell them (at the current price), forcing risk-tolerant investors to offer a premium to entice more risk-averse counterparts to take the other side of their trade, which drives markets up. The reverse is true when risk aversion (red line) is higher than risk tolerance (green line). The net balance between risk tolerance and risk aversion levels is used to compute the ROOF ratio in the top charts, representing the sentiment of the average investor in the market.
The blue shaded zone between levels 3-4 for both indicators, represents a reasonable balance between the supply and demand for risk in the market. Conversely, when both lines are outside of this blue zone, the large imbalance in the demand and supply for risk can lead to an overreaction to unexpected news or risk events.
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Developed markets ex-US:
1 If sentiment is bearish/bullish, a negative/positive surprise on these data releases could trigger an overreaction.