An analysis of risk sentiment moving into the new year

2018年12月29日

The SP500 has over the recent weeks broken through some well defined support levels and looks set to close red for the year. As a barometer for risk trends and overall market sentiment the current price action does not appear to embody confidence among investors. Rightly so as there are a plethora of fundamental headwinds that have got investors nervous at the moment and it can often be hard to pin point which headline or market theme is going to drive price from session to session. However known fundamental risks that have existed in the market for an extended period and have had time to be priced in often do not elicit protracted, sustained moves. Many of the fundamental challenges ahead are already well analysed by investors; trade wars, brexit, political unrest in europe, slowing global growth and central bank policy, because of this the calamitous types of crashes that have occurred in the past (which were caused by the rapid onset of mostly unforeseen circumstances) is unlikely to repeat itself this time. Not saying that it can't happen, simply that I think it is less likely which is why I would caution traders from aggressively trying to chase prices lower. Also a skim through news articles and financial opinion pieces reveals an almost unanimous opinion of a market and US economic decline in 2019, the only disagreement being the severity. As we know the markets are extremely fond of putting the popular opinion to the sword. Attached is a chart of the SKEW index which measures investors perceived risk of a black swan type of event occurring, as we can see it is sitting very low. This is in line with the opinion that although there are risks, investors are satisfied with their understanding of them and the ability they have to mitigate damage to their capital. However the very real danger this poses is that should an unforeseen event occur in an already very fragile climate investors will be caught completely unprepared. The rapid onset of risk aversion that this might trigger would be horrific for the SP500, equities in general and all other risk correlated assets. So to summarise, I believe at the moment investors know and are preparing to manage the risks and challenges facing the US and global economy going into the new year and because of that a precipitous market fall is unlikely, unless some new predicament develops. In which case they have almost totally priced this out and havoc will ensue.