A Hungry Risk Appetite
As various concepts become popular, we
often see brokerage firms hop on board and come out with products they
can sell to capitalize on the trends.
We're seeing that in spades with
volatility products. Somewhat related are "risk appetite"
indicators, and a handful of firms have introduced different such
measures, which tend to look at market behavior like credit spreads,
equity and foreign exchange volatility, gold prices and sector relative
performance (such as between defensive sectors like utilities and
economically sensitive sectors like financials).
We combined three of them and normalized
them into a single index. The chart shown to the right is a 21-day
moving average of that index.
Macro Risk Index
Carry Risk Index Plus
As the index rises, it means that investors are becoming more and more
risk-averse. An index reading of 1.0 would mean that they are the
most risk-averse possible.
As the index falls, investors are seeking
more and more risk. An index reading of 0 would mean that everyone
has gone hog-wild and thrown caution to the wind.
The 21-day moving average just dipped
below 0.2, one of the more risk-seeking levels we've seen since 1997.
A shorter-term average, say over the past 5 days, would be at 0.1 and
approaching the lowest levels in the past 15 years.
Low index levels, meaning very high risk
tolerance, isn't an automatically contrarian sell signal for equities.
But when we hit a low level and reverse back up (the red arrows on the
chart), stocks tended to struggle. Conversely, periods of very
high risk aversion that then started to reverse (the green arrows) were
decent intermediate-term buy signals.
This serves as confirmation to the
Smart Money and Dumb Money Confidence
that we're at an extreme of risk-seeking behavior. These can
stretch out for some time, as we've already seen, but that doesn't
lessen the risk of a sudden reversal.