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If you get the sense that today’s U.S. equity investors are eager to dismiss bad economic news, and quick to embrace the good, your instincts are correct.
That’s according to an analysis by Qontigo subsidiary Axioma, which recently developed a method for measuring stock market sentiment called ROOF score, an acronym that stands for “risk-on/risk-off.” The U.S. stock market is now registering a roof score of 4.8, which is in the 95th percentile of historical readings — meaning that market action has very rarely betrayed more bullish sentiment.
Read: Beware stock-market ‘FOMO’ as Wall Street churns out records, says long-term bull
“With sentiment this strong, Wednesday’s data releases on third-quarter GDP and personal spending would have to come in well below consensus to shake investors confidence,” said Olivier d’Assier head of applied research at Axioma said. “On the other hand, even a slight beat on forecasts is likely to be met with an over-reaction on the upside.”
The U.S. stock market’s ROOF score has been steadily rising since it’s low on Oct. 2nd, the day after a surprisingly poor reading of the Institute for Supply Management’s index of manufacturing conditions showed it contracting at the fastest pace since the Great Recession of 2008, while the growth of the services sector also slowed at a worrying pace.
Since Oct. 1 the S&P 500 index SPX, +0.22% has gained 6.6%, the Dow Jones Industrial DJIA, +0.19% has risen 5.6% and the Nasdaq Composite index COMP, +0.18% has advanced 9.3%. Given that the U.S. market’s ROOF score has risen this week from an already high 3.4 reading last week, d’Assier said that better-than-expected data “and even the signing of a mini trade deal might simply induce profit taking as we head into the end-of-year holidays and the associated lower volumes.”
Axioma compiles its ROOF scores using ten metrics that have shown historically to be good predictors of investor reaction to new economic data:
Axioma For instance, aggressive buying of growth stocks or highly leveraged stocks indicate a risk-on mood, while buying of dividend paying stocks or value stocks indicates risk-off sentiment, and the resulting score can predict market reaction to new information.
D’Assier said that such a high degree of stock-market optimism doesn’t tend to disappear on its own. “There needs to be a trigger for that, some news that makes people change their sentiment,” he told MarketWatch. Data due Wednesday, including a revision of U.S. third-quarter GDP growth, are not likely consequential enough to dislodge the bullish mood, he predicted.
“Unless Trump comes out with a worrying tweet on trade,” D’Assier said, “I think that sentiment is likely to stay as it is, because you have low interest rates, earnings have not been as bad as feared, and consumers are still confident.”
