How We Know We're In a Risk-On Environment

JC Parets
January 22, 2021

The market has been gaining from strength to strength and if anything, we see greater participation across the globe as this rally matures into what looks like a long-term bull market.

One phrase we hear pretty often during such bull markets is the "Risk-on environment". So what is a Risk-on environment and what are the indicators that allude to such a set-up?

Let's take a look at some charts!

For some time now we've been stressing about stocks outperforming precious metals and small-&mid-caps outperforming Nifty50. While these indicate asset-class and sector rotation, the implication of both these outcomes is a risk-on environment. It translates into market participants consciously selecting high-risk set-ups in order to gain from increasingly rewarding returns.

In a typical risk-on environment, Gold underperforms stocks as can be seen in the chart below. Demand for this precious metal suffers in comparison to other asset classes as the risk appetite of market participants increases. Hence, stocks become a natural favourite.

While safe-haven bonds witness a dip, Emerging market bonds that are perceived to be highly risky, become more popular as investors begin to look for high yield bonds. A weaker dollar comes into play here as well.

Another notable sign of the willingness to take on more risk is when Emerging markets begin to outperform developed markets. With the current rally in place, Emerging markets are breaking out a 12-year resistance! If this isn't a risk-on environment, I don't know what is!

The last chart we will discuss is the AUS/YEN currency ratio. This currency pair is a good indicator or of a risk-on environment as it implies the global risk appetite. A positive AUD/JPY trend indicates risk-seeking dynamics while a negative AUD/JPY trend indicates risk-aversion dynamics.

These are some of the risk-on indicators we track, which give us an idea about market sentiment and broader market participation. Going by the charts shared above, the current market rally has not indicated a weakening momentum or trend over a long-term time-frame, and until then, we will continue to remain overweight on equities and base metals.

 

Thanks for reading and please let us know if you have any questions.

Allstarcharts Team

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