Summary: It’s inauguration week in the US, what could possibly go wrong? Let me think. A sudden gathering at state capitols of large, passionate, tragically ill-informed, and potentially hostile crowds of Trump supporters – recognizable for their Rockwellian U.S. averageness, solid GOP upbringings, a lack of mask-wearing or any effort to social distance, and a high number of gun ownership per capita. Worst case, inauguration day turns violent. Best case it turns into a super spreader event.
Investors have a core held belief about sowing and reaping. The seeds of doubt about a peaceful transition of power in the US were definitively sowed two weeks ago, with the attack on the US Capitol. This week, sentiment in the US weakened further ahead of a potential reaping this coming Wednesday. But, as they did then when they chose to ignore those shenanigans two weeks ago, markets rose last week and seemed to refute investor sentiment by observing that their Propter Hoc isn’t even a Post Hoc (i.e., markets didn’t fall after the (first) violence).
Elsewhere, sentiment remains buoyant in developed Europe and the UK, completely directionless in Japan, and dangerously weak in Asia ex-Japan as investors there ponder about the future of US-China relationships under the new US administration.
US markets say they don’t care about the attacks on the US capitol, but investors kind of do.
Both US ROOF Ratios headed lower for a third consecutive week taking the Sector ROOF into Neutral territory (green line in top chart). The SELL signal triggered by an abrupt change of sentiment (i.e., >+/-0.5 in 20-days) remains in place (bottom chart) but markets seem to be ignoring its call for the time being. Twice in the recent past (Aug 2020 and October 2020) markets have deviated from sentiment only to retrace their steps afterwards. This time, investors are torn between being upbeat about the increased fiscal stimulus package and worried about why politicians believe the economy needs that much help. In short, they like the stimulus but are fearful of the motive behind it. In the background, of course, there is also the potential for civil unrest pitting Americans against Americans. Markets prefer when Americans are fighting a foreign foe, not a domestic one.
Sentiment in Europe remains strongly supportive of higher market levels in the short-term.
Sentiment in Developed Europe remains firmly anchored in the bullish zone after recovering in December and shooting up in January post Brexit Trade deal (top chart). But sentiment alone has never been enough for European markets, as evidenced by the long summer period spent in bullish territory but with a sideways market. Investors there tend to be more conservative and require economic confirmation before pushing markets to new highs.
The BUY signal triggered at the start of December remains in place, supportive of market’s advance in the near term (bottom chart). Europe has avoided a no-deal Brexit and is looking forward to a more open and cooperative US on the trade and international relations front. At this point, it will take some dire economic data to knock investors’ off their bullish pedestal.
Global and Asia ex-Japan market performance continued to diverge from investor sentiment.
The STOXX Global 1800 index continued to rise this past week despite weakening sentiment. Both ROOF Ratios have been declining for three consecutive weeks now with the Sector ROOF falling deeper into Neutral territory (green line in top chart). The scores for risk tolerance and risk aversion ended the week at equilibrium signifying that the demand and supply for risk is evenly matched.
Market performance in Asia ex-Japan is now completely at odds with investor sentiment and the large gap between the strength of market returns and the weakness of investor’s cognitive bias is worrisome (bottom chart). The supply and demand balance for risk is now firmly in favor of supply signifying that investors’ cognitive bias is becoming increasingly bearish. In this state, a negative event (e.g., escalating violence in the US, deterioration in US-China relations, etc.) can trigger this negative bias into action. The more numerous risk-averse investors would then be forced to offer large price discounts to their less numerous risk-tolerant counterparts to dump their risk assets.