Risk on, Risk Off

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In our previous edition we shared a perspective of how collective market participants, within the stock market, are viewing the consumer discretionary sector compared to the more conservative consumer staples sector.

Historically, when participants expect some level of economic vibrancy, as they look out on the timeline, they will be more enthusiastic toward the consumer discretionary sector as compared to the consumer staples sector.

Here, they will bid up discretionary companies more than that of consumer staple-oriented companies, which can be charted in a relationship chart, or a relative strength chart, as it is more traditionally known. This approach allows for a view of how collective participants are assessing the two sectors relative to one another.

This was the topic of our previous edition. We briefly revisit it here again because we are extremely vigilant on all the market-based relationship views we monitor in light of building questionable behaviors emanating from some of them.

In regard to the relationship of consumer discretionary to that of consumer staples, we have seen some deterioration in the relationship since sharing this just a week ago.

Importantly, at this stage, the relationship is not blinking red, “danger, danger, beware of imminent issues,” but it is displaying some increased stress. Our vigilance notes this additional stress, if only marginal at this stage.

We offer this primarily because when participating in historically high valuation market landscapes (in our current market landscape, we are epically highly valued, as offered in somewhat recent editions), things can turn sour in a hurry, using history as a guide.

Highly valued markets can also be thought of as perfection markets, if you will. That is, they are priced, and hence valued, for socioeconomic perfection to unfold as the near-term timeline unfolds. As most know, perfection is rarely achieved in any endeavor, let alone for a massive socioeconomic landscape.

Risk Assets

If we take a big step back and look at markets through a broad historical lens, we can clearly see the ebb and flow of risk tolerance by collective market participants. Think, risk on, risk off.

Interestingly, when risk assets have been bid up for quite a while - think, “risk on” - it seems as though said assets offer no risk at all. How can they be risky? They have been generally bid higher over x time.

We offer this because risk assets are always risk assets. That is, risk assets certainly can and do, go up, and they certainly can and do, go down.

Just because participants have bid up said assets consistently in recent time does not mean they will not turn from those same assets, en masse, without notice.

Well, we should check ourselves here in that we say, “without notice,” but they do inadvertently offer some level of notice via the trail of evidence they leave behind in their collective trading operations.

Again, this is why we consistently run a plethora of relationship views in order to constantly monitor their trails of evidence, be they positive or negative, in the wake of their trading operations.

In addition, it is not just about the aforementioned relationship charts, but it is also about how key areas of risk are performing unto themselves. This can mean direct views of the stock market itself, or certain areas within the stock market, and it can also mean direct views of other asset categories.

This is where we broaden out and emphasize “markets,” as in plural, rather than “the market,” as is typically inferred to mean the stock market.

Is Speculative Fervor Building or Reducing in Strength?

Markets across the board can offer feedback loops to each other through the lens of various behavioral observations. Namely, gauging the speculative tone across market landscapes. Is there a speculative fervor, and if so, is it reducing, or is it building in strength?

Gauging the speculative tone across markets can aid in identifying developing market issues before said issues are even noticed by most.

If speculative fervor has been in play and is reducing, then it is important to identify it and to continue to monitor it, as surely it will bleed across markets if it becomes a thing. Again, think, “risk on, risk off.”

We absolutely have had speculative fervor in the broad market landscapes for some time. For example, in the stock market, you cannot build a valuation backdrop of historic proportions and not have a speculative underbelly coinciding with it.

In markets outside of the stock market, we are seeing some interesting behavior that does not assure speculative fervor is heading for the exits, but they are worth noting.

Bitcoin is one that has chirped up of late.

Bitcoin is a worthy speculation gauge and it has offered, in recent days, that speculative fervor may be getting a little antsy. That is, collective market participants’ willingness to go deeper and deeper into speculation may be waning.

With this, participants lopped off 16% of Bitcoin’s price in less than a week in its recent peak-to-trough move. Under our views of monitoring the general speculative tone and whether we are building in strength or reducing in said tone, this 16% drop certainly caught our attention.

Relative to the stock market, the volatility index, which is known as the VIX for short, has reflected a change in its dormant behavior of late. Keeping it very simple, the VIX can be thought of as a risk meter for the stock market.

When the VIX rises, it offers volatility concerns, which can build rapidly once started. It has been relatively dormant for the bulk of the summer and thus far in the early fall season, until recent days.

In the corporate bond world it is worth noting the triple C’s are attempting to round over and move lower in price and higher in yield. Speculation seems to be attempting to walk away a bit from this class of bonds. Triple C’s?

Triple C’s (bond ratings of CCC and below) are near life support in good economic times, let alone in weak or weakening economic times. When collective market participants develop any concern about a downstream weakening in the economic landscape, triple C’s are at notable risk. With this, we watch them closely.

High-yield bonds, which are more recognizable under their moniker of junk bonds, are not nearly as at risk as triple C’s, but they certainly have a standing in the high-risk category.

We have been noting that here too speculative fervor has been quietly suggesting it is leaving the scene as these bonds have begun a rounding-over process whereby price is reducing and yields are rising, albeit subtly at this stage.

Importantly, very importantly, none of the above observations assures imminent general market issues across markets, but we are noting their subtle, and in some cases, not-so-subtle messaging as collective participants offer tells via their trading operations.

We view these as worthwhile notes to share in light of the speculative underbelly that supports so many markets. With this, monitoring any sign of a change in speculative behaviors from general participants is an important process.

We will continue to share market-based observations in coming editions as a central theme for the bulk of the remaining calendar year. It should be an interesting close to the year across markets.

I wish you well….

Ken Reinhart

Director, Market Research & Portfolio Analysis