What Risk Appetite is Telling Us About The Current Market Environment
In each week’s Thrasher Analytics letter, a chart of risk appetite is shown and discussed. This chart explores different ratios believed to provide insight into the risk appetite of the financial markets. An average is then taken to show a composite of risk appetite. Each ratio is evaluated on its position within its range over the last year. When a ratio is rising, it suggests (based on that metric) risk appetite is rising. When the collective is improving, that’s been bullish for equity markets. Whereas, when risk appetite declines and diverges from the broad equity market then it could lead to a move lower in stocks as investors become more cautious on their positioning.
Below is a look at the ratios, showing which are rising or declining over the last 35 days. When the colors go from green to red, we know the ratio is moving lower.
This chart shows the average of the ratios. When the Average of the Primary Risk Appetite Ratios is above 50, then risk appetite is in the upper half of its 1-year range. Note that we peaked in risk appetite back at the end of the first quarter and it began to diverge lower as defensive sectors began to improve, international markets were unable to keep up with domestic U.S. stocks and gold was rallying higher, to show just a few examples. This has taken the average ratio to under the 50th percentile and recently back up slightly to 53rd percentile.
Risk appetite is not intended to be a timing tool but similar to breadth, identify the type of environment the market is in. Are most of the risk ratios rising and confirming an uptrend, or vis versa (like we had at the end of 2022) are they rising and diverging from a declining market, suggesting risk appetite is improving and stocks could soon rally? These are the questions these data sources attempt to answer.
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