From the desk of Steven Strazza @Sstrazza and Grant Hawkridge @granthawkridge
In today's post, we’re going to do an update on some of our favorite and most essential intermarket indicators. We’ve also updated our risk checklist so we can discuss the changes that have occurred over the past week or so.
Are market participants embracing more or less risk these days?
We’ll get there.
We've been obnoxious about our theme that this remains a messy environment for stocks, which is nothing but classic "year two" bull market behavior.
But guess what: That’s just what it is right now. You have to play the cards you’re dealt, and right now they’re not the best. This is particularly true for trend-followers like ourselves.
Let’s talk about why.
Our custom “Risk-On” and “Risk-Off” indexes have been a perfect illustration of the 2021 market environment.
This is what a hot mess looks like… and it’s true for both custom indexes as well as the ratio of the two!
These charts do an excellent job of illustrating just how sloppy things have been for the better part of this year. Whether we’re discussing either of the indexes or the risk-on/risk-off ratio, they’ve all been consolidating sideways for several months now.
But there’s a lot going on here, so let's break it down and talk about what’s actually in these indexes…
In the top panel, we have our equal-weight Risk-On Index, which is comprised of areas that tend to lead in a strong bull market. They include Copper, High-Yield Bonds, the Australian Dollar, Semiconductors, and High-Beta Stocks.
Moving to the middle panel, we have our equal-weight Risk-Off Index. Assets here would include things like Gold, Treasury Bonds, Yen, and, of course, Utilities and Staples stocks. These are the types of assets that investors tend to favor when they seek safety and position defensively--basically, the opposite of what you buy when you embrace risk.
In the bottom panel, it’s just a ratio of the two indexes.
All three of these charts highlight the indecision of market participants these days.
When looking for evidence the market is ready to break out, break down, or continue to move frustratingly sideways, we like to look at our risk-on/risk-off ratio, as the chart usually provides a good indication.
Right now, it’s giving us very little to work with. It’s just a choppy, range-bound mess. And that makes sense considering what we’re seeing everywhere else!
If the ratio starts to make new highs, the procyclical, global growth thesis is probably ready to resume and the US 10-year yield is likely reclaiming 1.40, along with many other key assets we’re watching.
On the other hand, if it begins to move lower, we may see some corrective action for stocks and risk assets.
But, without a decisive signal in either direction, a "sit on your hands" approach remains the most appropriate for now.
As many of you already know, we also love to use checklists as a roadmap during times like these. It's a great way to visualize what we consider the important charts in the world right now and whether they're above or below the levels we’re watching.
We believe that how the charts on our risk checklist resolve will hold critical information about the likely future direction for markets.
It’s similar to the information we can gather from the chart above, just visualized differently with a bit more detail:
Our updated checklist shows a current reading of 48% in risk-on territory. Despite the selling pressure since last week, the list has held up quite well.
But take a closer look now and notice just how many of these charts are sitting only a few percentage points away from their key levels. This tells us that a few big up or down days could swing this list strongly in favor of either the bulls or the bears.
We wish we could tell you which one it’s more likely to be, but for now it’s really a draw. We need more information, more resolutions. Then, we’ll be able to at least lean in a direction.
Here’s a time series of the table showing the percentage of assets in bullish territory charted beneath the S&P 500. Notice how we found support around 40% and bounced higher off this level even after last week’s weakness:
This resilience is a feather in the cap for the bulls.
If we get a move above the checklist’s highs from June or last week, we just might find ourselves in an environment where markets are resuming higher, in line with their underlying uptrends.
Until then, we’re likely to be rewarded for our patience--just as we have been for months now.
We continue to believe things will eventually resolve higher…
The main question we’re asking is simply, “When?”
No one knows. It could be in the next few days, or it could take another six months.
We’ll always remain flexible and open to new information as it pours in!
But, for now, the information in front of us remains mixed.
