Axioma ROOF™ Score Highlights: Week of February 3, 2025

Investor sentiment declined last week in all markets we follow, except in Australia where sentiment shifted from neutral to positive, and in the US where it improved from bearish to negative. Overall, sentiment has weakened since the start of the year as investors become tariff-ied of the monetary policy implications of a global trade war which the Fed has already warned could tilt the risk of inflation to the upside.

Over the past two years, building a US portfolio has been relatively straightforward. Start with the Magnificent Seven: Amazon for consumer spending, Apple for mobile hardware, Google for the Internet of Things, Meta for social media, Microsoft for software, Nvidia for AI, and Tesla for, well, political correctness. Add to this core group JP Morgan-Chase for the economy, and you were set. This portfolio allowed you to closely track the entire US market and achieve a tracking error of less than 2.5% against a global developed market benchmark. The only cost for this convenience was concentration risk. What could go wrong?

It is starting to look like serious investors just don’t think that sentiment, la spécialité de ces Highlights, is serious. As mentioned last week, US investor had turned bearish as of January 16, meaning the number of risk-averse investors far outweighed the number of risk-tolerant ones int eh market. Given this large imbalance in the potential supply and demand for risk, all it takes is a trigger – an unexpected negative news – to turn the market into a Schopenhauer zone, where man is wolf to man. And on Monday January 27th, China’s DeepSeek provided the trigger, turning amity into enmity in seconds.

Investors have been used to thinking of geopolitics as minimally invasive radiofrequency-based vein ablation surgery. They’re about to experience complications, leading perhaps to open heart surgery. The first few weeks of the Trump presidency have had everything in it, from the predictable endings to the unpredictable beginnings. Trump is an overture to unknowability and investors need to become open to this kind of uncertainty.

But where there is uncertainty, there is also possibility – this is the very nature of transactional geopolitics. As we saw after last week’s DeepSeek-triggered selloff, a relative economics develops where all that panic selling by some, is making for a lot of opportunistic buying by others. But whether these ‘others’ offer to do the buying at a premium or a discount depends on the balance of supply and demand for risk (a.k.a., sentiment) in the market at that point in time. As of now, geopolitical uncertainty continues to make this a buyer’s market.

The key for investors is to identify the connections between geopolitical shocks and market movements. For example, when Russia invaded Ukraine in February 2022, the resulting spike in oil prices affected energy costs and inflation, prompting the Fed and other major central banks to raise interest rates. The latest FOMC minutes highlighted the “likely effects of potential changes in trade and immigration policy” as a reason for “almost all participants judging that the upside risk to the inflation outlook has increased,” setting the stage for a potential conflict between the Trump White House and the Fed. Investors should anticipate this clash and other challenges to the system of checks and balances across various branches of government before declaring an all-clear.

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

• US: 25% Tariffs on Mexico & Canada (just another 12 hrs. trade war?), PMI data and the Jobs report. Earnings reports from PepsiCo, AMD, Pfizer, Walt Disney, Qualcomm, Eli Lilly, and Honeywell.

• Europe: BoE interest rate decision (exp. -25bps). Inflation and retail sales, and PMI data for the Eurozone. Germany’s factory orders.

• APAC: PMI data for China. CPI and PPI data for Japan. Opinions from the BoJ on interest rate outlook for 2025.

• Global: Implementation of Trump’s trade and immigration policies.

[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 ‘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.