We recently introduced our Risk Barometer. It uses risk measures across various markets to determine whether markets are in ‘risk aversion’ or not. This would help indicate how defensively to position oneself – for example by liquidating risky positions like equities or credit. Two weeks ago, the Risk Barometer was signalling ‘risk neutral’. The question is, after recent equity weakness has the signal changed? Well, the short answer is ‘no, but…’.
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We recently introduced our Risk Barometer. It uses risk measures across various markets to determine whether markets are in ‘risk aversion’ or not. This would help indicate how defensively to position oneself – for example by liquidating risky positions like equities or credit. Two weeks ago, the Risk Barometer was signalling ‘risk neutral’. The question is, after recent equity weakness has the signal changed? Well, the short answer is ‘no, but…’.
The Risk Barometer did flirt with ‘risk aversion’ last week partly as credit risk started to increase. But most measures have eased this week, so the Risk Barometer is just above its three-month average. We would need to see it be one standard-deviation above the three-month average to signal ‘risk aversion’.
Equity risk remains elevated and is closest to the ‘risk aversion’ threshold. Credit risk is next highest but has eased from last week. Then we have EM risk with a similar dynamic. The outlier market is FX, where FX risk has plunged (see first chart). We would need to see FX volatility to pick up for the overall risk picture to worsen.
Finally, we are monitoring politics – whether trade wars, impeachment dramas, or Brexit. All of these could conspire to push the Risk Barometer into ‘risk aversion’.
We can directly measure political risk, through policy uncertainty indices. Spikes in uncertainty have coincided with our Risk Barometer measure being in ‘risk aversion’ (see second chart). Interestingly, though, the Risk Barometer seems to lead the uncertainty index. That said, the recent spike in uncertainty has been lower than witnessed over the summer and it has started to fall in recent days.
Overall then, the risk picture looks worrying, but we aren’t in panic mode yet. We need to watch FX markets for a cue on whether things will take a turn for the worse. We’re also watching the various political dramas, though so far, they haven’t been as acute as those we saw earlier this year.
(The commentary contained in the above article does not constitute an offer or a solicitation, or a recommendation to implement or liquidate an investment or to carry out any other transaction. It should not be used as a basis for any investment decision or other decision. Any investment decision should be based on appropriate professional advice specific to your needs.)