Investors Of All Kinds Reach For Risk

Steve Strazza
January 29, 2021

From the desk of Steve Strazza @sstrazza and Louis Sykes @haumicharts

The market is giving us absolutely no reason to play defense right now.

Regardless of the asset class, it's the risk-takers that are having their way in this environment.

Investors stretching out along the risk spectrum is a point we've been hammering home for some time now, particularly in our weekly RPP Reports - like this one.

Not only is this true on absolute terms, but we're also witnessing cross-asset relationships progress higher and in favor of risk-asset which can only be taken as a positive.

It's not often we see all asset classes in agreement with each other, but when we do, it's a significant driving force that supports the risk-on trade and suggests higher prices to come.

In a piece from a few weeks ago, we explored the absolute trends in the commodity and currency complex that were suggesting healthy risk-taking behavior.

In this post, we'll dive into the relative trends at play across ALL asset classes in an effort to illustrate the same.

Let's jump right into our first example. This one speaks to Equity Market risk-appetite.

If you read our work often, you might be sick of seeing this one. If that's the case, then we're doing our job... because it is just so important.

Here is Large-Cap Consumer Discretionary $XLY ripping higher in a vertical line relative to Consumer Staples $XLP.

If there was ever a magic indicator, this one would be pretty damn close. New all-time highs means all is well and good for US stocks.

But what about International stocks? They've certainly picked up the pace lately and we've discussed the bullish expansion in participation we continue to observe.

Let's take a look at what one of our favorite intermarket risk-appetite ratios is telling us right now. Here is Emerging Markets $EEM relative to the S&P 500 $SPY.

And we're seeing the very same thing in global equity markets as the higher-risk Emerging Market stocks just broke out of a nice base relative to the US and are now trading right around their highest level in 2-years.

Investors rotating money out of US Large-Caps in order to deploy capital into some of the riskiest regions in the world is simply a common characteristic of bull markets.

Let's move on. What is the Commodities Complex telling us these days?

Here is a look at Lumber vs Gold?

Looks a lot to me as if price recently broke out of a decade-long base and is now poised to resolve higher from a smaller 3-year base.

If this ratio is above those multi-year highs in the upper 0.40 range, the bias is higher... maybe even a lot higher considering the size of this base.

The thinking here is that Lumber is an economically-sensitive commodity. Its price is very much a function of things such as housing demand, construction, and general industrial activity.

Gold, on the other hand, outperforms in environments where investors are worried about the economy and looking to position defensively.

Notice, by the way, that when we overlay this ratio against Housing Construction stocks relative to the rest of the market, they look damn near identical.

If one goes, the other is likely to follow. We think this is the higher probability outcome and want to continue to look to Homebuilders as a way to express our bullish thesis on stocks.

What is the Bond Market telling us now? After all, they say that's where the smart money is...

What I mean by this is that historically, Credit Markets have acted as one of the most reliable indicators for stress in other asset classes. For this reason, it is an area we pay a lot of attention to when assessing risk-appetite and the markets health in general.

Well, it's the same story as all the rest...

We usually show our ratio of High Yield or TIPS vs Treasuries to illustrate risk-appetite, but we decided to switch things up. This is a testament to just how broad-based this evidence of risk-seeking is.

The chart above shows Emerging Market bonds outpacing their more defensive US counterparts, as well as US Corporates consolidating in a continuation pattern after grinding gradually higher relative to Treasuries off the March lows.

With that said, our traditional ratios of High-Yield $HYG vs Investment Grades and Treasuries of the same maturity (not shown), and TIPS versus non-inflation-protected Treasury Bonds... are also both trending higher.

It's always nice to have the Bond Market confirm what we're seeing in the Stock Market. Right now that is definitely the case as investors are reaching further and further out along the risk spectrum in an effort to beat their benchmark.

Bottom line: Nothing but positives across the board from our Credit Market ratios.

Last but not least, let's turn now to Currency Markets.

How about this breakout and what appears to be the early stages of a long-term trend reversal in Aussie/Yen.

Given this risk-on pair has diverged with equities at historic peaks, like in Q1 2020, seeing this cross at new multi-year highs is definitely supportive of our bullish macro thesis.

Now that the AUD/JPY is well above the long-term Fibonacci retracement and the 2020 Q1 highs of 76, we think the bias is definitely to the upside toward 87.50.

And any discussion around risk appetite nowadays would simply be incomplete without mentioning Crypto. Once again, this space has become the latest craze.

Despite Bitcoin correcting a good bit from its recent high, we've witnessed a bullish rotation into Altcoins. Altcoins are any Cryptocurrencies that aren't Bitcoin.

These smaller market-cap Cryptocurrencies carry a significantly higher level of risk, so seeing these guys outperform is yet further evidence of risk-appetite and a positive development for the entire crypto space.

While these coins are still the secular laggards, seeing this broadening in participation as they all show strength versus Bitcoin during this recent correction is an encouraging sign for this new asset class.

So in conclusion, the weight of the evidence continues to favor the bulls and risk-takers... In all asset classes.

Investors are moving further and further out on the risk spectrum as the market is giving them few other avenues to generate alpha... if any.

In order to outperform their benchmarks, managers are being forced to ramp up their exposure to risk. This type of behavior can become a powerful feedback loop and propel prices of these risk assets even higher.

Are we onto something here? What are we missing? Let us know.

And definitely send over any examples of intermarket or cross-asset charts you're looking at that are showing risk-aversion, not appetite.

We're having trouble finding any!

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Allstarcharts Team

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