America The ‘Financial Prozac Nation’

Ok, so “risk taker”, “swashbuckler,”and fearless macro pirate who thinks it’s probably your fault that macro fund managers are terrible at their jobs, Cameron Crise, is out with a good note on Wednesday.

Although we enjoy poking fun at the names he’s implicitly called himself (see above), there are a lot of things to like about old Cameron. For one thing, he was the target of Jeff Gundlach’s first Twitter meltdown, so that should endear you to Crise by default.

But another thing to like is that Cameron does his homework in terms of looking at the data. Now that doesn’t mean you have to think he’s looking at the numbers the right way or even that you have to think he’s looking at the right numbers in the first place, but what you do have to respect are his efforts to back up his assessments with math.

On Wednesday, Crise set out to examine two (related) points of contention among market commentators: whether last week truly counts as a “risk-off” episode and whether investors really are exhibiting signs of euphoria. That latter point has been debated by sellside desks endlessly, and if you’re interested in one recent take on it, you can read some color from Citi’s Tobias Levkovich here.

Just for some visual context, here’s a look at SPY, HYG, and the VIX so you can kind of get an idea of how last week compares in terms of magnitude.

Ok, so with that, we’ll leave it to Crise, but we would implore you to pay particular attention to this:

In fact, there has never been a time when relative asset performance contributed so little to the risk indicator. What are we to make of this? It’s almost like investors are citizens of some financial Prozac Nation, emotions suppressed and buying all kinds of assets regardless of the perceived risk (or return).

Sound familiar?…

Via Bloomberg

It was only a week ago that markets turned jittery over possible nuclear tensions with North Korea, but already the incident seems all but forgotten. Amazingly, a few days of equity weakness constituted the biggest episode of risk aversion this year. By the same token, there are few signs of investor euphoria, either. Tracking relative asset performance may hold the key to identifying when a volatility spike will endure for more than a few days.

• These days many investors and sell-side institutions have a measure of risk appetite that they like to track. I have a proprietary indicator that I’ve used since 2003 which is designed to identify tradable shifts in investor risk sentiment.
• The index tracks the relative performance of “safe” and “risky” assets, changes in volatility, and the evolution of financial conditions. Last week’s market blip represented a 0.92 standard deviation event — the biggest dose of risk aversion since the runup to last year’s U.S. elections.
• Since I have been using this index, there’s never been a year without a one- standard-deviation risk-aversion event. The closest we’ve come was 2013, with a reading of 1.06 standard deviations.
• There are few signs of investor exuberance, either. The indicator shows a maximum risk appetite of 1.38 standard deviations in 2017, which is roughly average. Much of that represents the post-election flurry, however. Since the president’s inauguration, the maximum risk appetite has been 1.02 standard deviations — extremely low by historical standards.
• Unsurprisingly, volatility has been the “swing” component of the indicator this year. Financial conditions have been broadly if modestly supportive of risk appetite, while surprisingly there has been no consistent sign of risk appetite or aversion from relative asset performance.
• In fact, there has never been a time when relative asset performance contributed so little to the risk indicator. What are we to make of this? It’s almost like investors are citizens of some financial Prozac Nation, emotions suppressed and buying all kinds of assets regardless of the perceived risk (or return).
• So keep track of stocks vs. bonds, safe vs risky sectors, etc. At some point, relative preferences will return and investors will dump safe assets to buy risky ones, or vice versa. At that juncture, we’re likely to see bigger oscillations in risk appetite and reversion — and more volatility. Until then, it seems that investors are content to keep calm and buy assets.