For the last few months, we have been commenting on what we see as a disconnect between the strong rally in the S&P 500 index, the lack of confirmation from other market segments, and the weakness in economic leading indicators. Based on the most recent bout of volatility centered around trade negotiations, we believe it would be helpful to share some of the general charts that may be useful to gauge overall risk sentiment and what we believe is directly tied to the current trade negotiations.
Ned Davis Research has created a set of risk-on and risk-off indices based on their correlation to the MSCI All Country World Index (ACWI). The top four positive correlations to the ACWI are included in the risk-on index and the top four negative correlations are included in the risk-off index. Recently, the risk-on index has been underperforming and dropped below the 50-day moving average.
Ned Davis Research also tracks the percentage of risk-on and risk-off index constituents that are above their underlying 50- and 200-day moving averages. Recently, the percentage of risk-on constituents above their 50- and 200-day moving averages has been declining, while the percentage of risk-off constituents has been increasing.
In terms of market positioning, it appears that investor complacency has increased during the rally to start 2019. Net short positioning in the VIX or volatility markets is close to the levels seen at the end of 2017 and beginning of 2018. These positions were eventually unwound and helped contribute to a large spike in volatility and a sharp pullback in S&P 500 index.
Trader sentiment toward the S&P 500 index was close to a one-year high heading into May based on the NDR Daily Trading Sentiment Composite, and well into the optimistic range, but has since pulled back. The weekly sentiment indicator had made a new one year high at the end of April but has also started to come back down. Prior reversals in investor sentiment have been associated with market corrections.
This condensed list of sentiment indicators suggests to us that some caution in terms of risk taking is still warranted and we are not looking to increase our risk profile at this point.
Below are a subset of charts that we believe are worth watching to monitor developments related to the trade negotiations for one of two reasons; either they are directly tied to the discussions (like Asian equities, bonds, and FX), or they provide a good gauge of overall investor risk sentiment (like the Swiss Franc, Japanese Yen, and U.S. Treasuries).
Rank Dawson, CFA
Vice President, Strategic Planning
Boyd Watterson Asset Management, LLC
The views expressed herein are presented for informational purposes only and are not intended as a recommendation to invest in any particular asset class or security or as a promise of future performance.