‘High Levels Of Risk Appetite Signal Worse Asymmetry Of Returns,’ Goldman Warns (Again)

Well, you probably already know this, but low vol. regimes have a tendency to stick around for a while and it’s safe to say that tendency is even more entrenched today than ever thanks to modern market structure and the attendant “innovations” that create self-feeding loops.

That said, last week we got a taste (albeit a fleeting one) of how quickly things can change when everyone had a minor “freak-out” after lunch on Thursday.

For their part, Goldman thinks you should be cognizant of the rather self-evident fact that getting long assets that are already inflated invariably stacks the deck against you in terms of both what you can expect as far as returns go and the likelihood of a correction.

Read the color from the bank’s weekly “GOAL Kickstart” note below…

Via Goldman

Last week the rally in many risky assets took a pause, outside of commodities where oil (+9%) and copper (+5%) drove the second-best week of the year for GSCI (+4%). MSCI World has rallied 12%YTD, in line with its best starts since the tech bubble.

ACWI

In our view, a strong global growth backdrop and continuing search for yield has driven a recovery in risk appetite across asset classes, contributing to the strong returns. The last time we had such sustained risk appetite was in 2013, when equity markets were rallying across the US, Europe and Japan.

Credit is the asset class that has boosted our risk appetite indicator the most. The EM v. DM component of equity risk appetite has been a key outlier, consistent with EM’s outperformance this year.

Risk appetite can stay strong as the current low vol regime lingers. A key near-term risk to the carry-friendly low vol regime could be rates increasing too fast, in particular real rates. We are Overweight equities over 12 months due to the relative attractiveness of the asset class given little return potential in fixed income assets, but we expect more muted equity returns from here – also high levels of risk appetite often signal worse asymmetry of returns.

RiskApp

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