Risk Appetite is Declining
One of our research partners, Andrew Thrasher with Trasher Analytics, updated his Risk Appetite Ratio in his weekend report. Markets typically go up when risk-taking is high and vice versa. I think this is an excellent barometer to monitor risk-taking in the market, and I wanted to share it with you to support our shorter-term bearish lean.
The categories graphic in his letter is really small, so it’s a blurry copy, but a comprehensive list of the ratios he uses to formulate his overall number is below. They include things like High Yield Debt versus Treasuries. High-yield debt is much more risky, so if that ratio increases, then investors are taking more risk. Same for sectors like consumer discretionary (think Nike) versus consumer staples (think Walmart).
He then compiles all these different ratios into their own ratio, 0-100, and here are a couple of things we look for in the data.
50-above, the lean is risk-on; below, the lean is risk-off. As we sit today, we have been unable to break above that 50 mark since the market fell in early March, supporting our bearish lean.
The second is divergence, which is when the ratio diverges or goes in a different direction than the market. He illustrates this with those green and red lines.
You can see in November of 2021; there was divergence between the Risk Appetite Ratio, which was declining, and the S&P 500, which was going up. Same with the most recent market bottom in October. Risk Appetite Ratios had started to increase while the market was still falling. While he hasn’t drawn any lines yet, we’re leaning toward a divergence with the market slowly increasing while the Risk Appetite Ratio is fading. We need a more significant move in each to draw some lines, but the formulation is there.
Some of our favorite formulas, models, and analytics are leaning negatively, but that doesn’t mean the market has to decline. None of them are 100% accurate, far from it, so we’ll maintain an open mind and be prepared to pivot if necessary.
Have a great week!
Shean