Potential triggers this week: Post US Presidential Election transition and response from the Trump White House. Covid-19 and the policy responses across Europe and the US. Ongoing Q3 earnings and GDP updates from the Eurozone and the UK.
Summary: Sentiment bottomed out on US election day across the major markets of the US, Global Developed, Developed Europe, and Asia ex-Japan. Despite this turnaround, risk aversion levels remain elevated and risk tolerance low. In the short-term, much will depend on the policy response to a rising rate of new infections across Europe and the US. The election result provided only half the answers investors were looking for with the fate of the Senate still undecided until early January. The turnaround in sentiment clears the way for a short relief rally but with the supply and demand balance for risk still in favor of supply, investors remain more sensitive to negative news than positive ones. Japanese investors had been the only bullish ones left for weeks now with positive sentiment there allowing that market to continue to rise and reach a 29-year high on Monday morning.
US investor sentiment bottomed-out last week but retain a negative bias.
Both of our ROOF variants bottomed-out last week, albeit at their lowest levels since April (top chart). A continued improvement in sentiment this week would validate investor’s preference for the Biden/Harris win. The US market had been unable to rise to new highs in both August and October due to deteriorating sentiment. Indications are that a relief rally after weeks of uncertainty may be enough to reach a temporary new high this time around, but a sustained rally will require a more positive cognitive bias than current levels.
The turnaround in risk aversion and risk tolerance levels (bottom chart) needs to continue to provide more sentiment momentum for the current rally to last. The high level of risk aversion indicates that investors are still more sensitive to negative news than they are to positive one. Donald Trump remains the US President until noon on January 20, 2021 which means that domestic politics at the very least can be expected to remain volatile, albeit not economically sensitive. Investors will look for a consensus on the election result to build and the transition to proceed.
Sentiment in Europe halts its decent towards the bearish zone; is it temporary?
Sentiment across Developed European markets halted its decline last week after the US election results seemed to point towards a more reconciliatory administration there next year (top chart). A worsening Covid-19 situation and lockdown policy responses across several key countries had driven sentiment sharply down in the last few weeks. It remains to be seen if the rebound of the last two days is sustainable, or if, like in October, it is only a temporary reprieve along a continued path towards the bearish zone.
Investors’ levels of risk tolerance and risk aversion have been evenly matched there for several weeks now (bottom chart) keeping market prices in a tight range. In this neutral cognitive bias, investors will take their cues from ongoing news flow. Signs that the latest batch of policy response to the pandemic are working will help sentiment rise, a worsening infection count will make it fall.
Sentiment bounces off the bearish floor for both Global and Asia ex-Japan investors.
Global investors’ sentiment rebounded last week in line with major markets but remains in bearish territory (top chart), indicating that investors remain more likely to over-react to negative news than to positive ones in the short-term. Markets have rallied on positive sentiment out of the US Presidential election process but are now well ahead of sentiment and unless the latter is given strong reasons to rise, it may not have enough risk tolerance to maintain its current trajectory.
Sentiment in Asia ex-Japan also bottom-out last week but like its peers, remains in or near bearish territory. Markets there seem to also be welcoming the results of the US elections, but it will take more than hope to turn sentiment around in the medium term. Risk aversion levels in the region remain elevated and risk tolerance low, giving the region a negative risk appetite for the moment. Concrete wins for the region from these election results will be necessary to lift sentiment further.