Risk Appetite, Conviction, and the Search for Market Balance

Risk Appetite, Conviction, and the Search for Market Balance

What is risk appetite and why does the market seem hold a remarkable immunity against concerns levied against the financial system and economy?

Talking Points

• ‘Risk appetite’ or ‘risk sentiment’ are used by most market participants, but generally it reflects a confidence of the broader markets
• Conviction in market sentiment can range across extremes (fear to greed) but also as impactful or unmoored
• Recent record highs for major speculative benchmarks – like the S&P 500 – seem to defy fundamental fears, but that may not be unusual

What is Risk Appetite as a Systemic Market Sentiment?

While many investors, traders and observers focus on the specific markets that are of interest and pertinent to them, there is a generality of ‘the market’ when speaking on the financial system as a whole. Whether through financial media, general conversation or as a context to one’s own target market; that reference is often made as an overview and sometimes as a short cut.

As a big picture statement on the general health of the financial system, the overarching view of the collective can range from ‘risk on’ and the pursuit of higher returns (whether through capital gains, yield or other means) to ‘risk off’ which prioritizes safety and stability of funds. Common alternatives for this spectrum are ‘market sentiment’ or ‘risk trends’ with a spectrum that runs the extreme of ‘fear’ to ‘greed’.

Risk Spectrum and Markets’ Standing

Source: John Kicklighter

A Natural Skew in Market Sentiment

At present, it would seem that ‘risk appetite’ (or ‘risk on’) is the prevailing sentiment across most markets that fit in the risk spectrum – and most do. However, for ease of access, we reference the S&P 500 and major US indices as a touchstone of this market reflection. With the major equity benchmarks pushing record highs into September, there seems a heavy skew. That said, that same lean doesn’t necessarily come with roaring momentum nor volume (participation).

There is also plenty of fundamental threats quoted by the sceptics, but that doesn’t seem to have swayed the collective view. Is this evidence that the list of concerns are not relevant? Are the positives just that significantly more inspiring? Perhaps fundamentals are no longer relevant and sentiment itself keeps building its own momentum?

Current Risk Sentiment Standing

Source: John Kicklighter

‘Traditional Fundamentals’ and the Detractors from Speculation

In our podcast episode, we discuss that traditional fundamentals are still relevant and exert significant influence on markets. However event risk can exert limited influence and themes can take longer to develop a meaningful shift – especially from a ‘systemic bull trend’ to a ‘bear trend’. A current example can be found in the same ‘dual mandate’ that the Federal Reserve monitors to determine its stance for US monetary policy. While US unemployment has started to trend higher, it is still near historically low levels. In contrast, inflation pressures have levelled out at a pace that rests well above the central bank’s preferred level. So while priority of risk may very well continue its slow shift, there is plenty of road before a need for a strong dovish setting. And, that long lead time is something a market can see well in advance.

US Jobless Rate and Core CPI YoY (Monthly)

Source: John Kicklighter, US Bureau of Labor Statistics

AI Offers a Thematic Lighthouse for ‘Risk On’

In the absence of an urgent need to ‘de-risk’, there is a natural undercurrent of opportunism in the markets. One of the principal themes that Matt touches upon is the transformative value of AI (artificial intelligence). In contrast to a gradual benefit like a measured uptick in growth or even a sudden by limited influence such as a shift towards stimulus by a major central bank, there is an open-ended quality to the opportunity represented by AI.

That said, the appeal of this particular ‘north star’ and a concentration of appetite in prominent, top market cap stocks (like the Magnificent 7) reflect a centralization of the signal for ‘risk appetite’. If a top AI representative (like Nvidia) were to start a progressive retreat or a broader representative of the mega market stocks (like the Nasdaq 100), it could serve as a warning that the general mood of the market is turning.

Chart of the QQQ Nasdaq 100 ETF / DIA Dow ETF Ratio Overlaid with Nvidia (Daily)

Source: John Kicklighter, TradingView

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— Experts: John Kicklighter, Global Head of Content, Matt Weller, Global Head of Market Research