To The Moon

Investor sentiment is set to rise this week on the diplomatic breakthrough between the US and Iran on reopening Hormuz. Details on the exact conditions of the deal and next steps are still unknown, but as far as investors are concerned, you had them at Hormuz – Japan opened up 5% on Monday at a new record-breaking high. Still, we’ve been here before with peace efforts in the Middle East, and details, when they emerge next week, will matter for durability and credibility. For the Iranian regime, time upgrades survival to triumph, not defeat, so the reality on the ground may be unchanged from before the war began. Again. But if “unchanged” means a return to oil at $60-$70, markets are fine with that.

With war escalation off their call sheet for now, investors will keep an eye on deflating oil and energy prices and an ear on how this might affect the monetary policy calculus at the Fed during Wednesday’s press conference by incoming new Fed Chair Kevin Warsh. Investors will also keep one eye firmly on the AI story and how SpaceX follows through on its successful IPO, while the other ear will be kept on the upcoming Anthropic and OpenAI IPOs. Until now, rising geopolitical risk and a resilient economy meant that uncertainty was being repriced through rates, not spreads. And higher rates were precisely what put pressure on AI valuations. Will the Fed now be able to lift that pressure?

As geopolitical risk recedes, the question of whether we are inside an AI bubble will return to the front page, displacing geopolitical risk as the main driver of investor sentiment. For a bubble, attention is nourishment, and AI has been getting all the attention since ChatGPT’s release on November 30th, 2022, culminating in last Friday’s creation of the world’s first trillionaire. Many commentators have drawn parallels with the Dotcom bubble of the late nineties – this isn’t the road not taken – but there are also differences. So do look back, but don’t stare.

On the similarities, for a start, the Netscape IPO of August 1995 demonstrated that a 24-year-old founder could go public and create life-changing wealth overnight. And for a second start, if you can have two starts, it convinced Wall Street that unprofitable, high-growth tech companies deserved public capital at scale. Netscape made millionaires—and convinced Wall Street that profit could wait. SpaceX made a trillionaire—and convinced Wall Street that scale could be priced upfront. The question for investors now is: where do the similarities end? The internet had promise, and Netscape gave it a price. AI has promise, but did SpaceX just give it a ceiling?

On the differences, the Netscape IPO didn’t burst the Dotcom bubble, it started it by defining a regime shift on Wall Street – profits can wait. It was followed by Yahoo (1996), which scaled the boom, Amazon (1997), which validated e-commerce, and eBay (1998), which provided the monetization proof. The bubble didn’t burst until March 2000, when investors finally ran out of patience on the profitability front.

The causes of the Dotcom crash may have been entombed by new technology and a new generation of investors, but they have not been destroyed. They wait quietly in the dark for someone to dig them up again. Bad news is patient.

If you are struggling with this AI jigsaw puzzle that came in an unmarked box, our team is at work, with our stress tests at the ready and our analytical shovel in hand. If you are willing to listen, we’re willing to dig.

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

• US: FOMC meeting.

• Europe: BoE interest rate decision.

• APAC: Japan inflation and machinery orders data and BoJ interest rate decision. China’s industrial production, retail sales, unemployment, house prices, and fixed-asset investment data.

• Global: Continued peace in the Gulf and falling oil prices and any theatrics at the G7.

[1] If sentiment is bearish/bullish, a negative/positive surprise on these data releases could trigger an overreaction.

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 Score, 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 Score 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.