Rotation, not risk-off

In response to client questions, we update some indicators we discussed back in January to address the debate about whether recent market action is indicative of a defensive shift (potential equity market top) or a rotation within equities that maintains a “risk-on” environment. Our current view, as it was in January, is that risk appetite remains broadly intact and the weight of the evidence suggests that we are seeing a rotation, not a “risk-off” environment.

Still a risk-on environment, but option traders remain nervous

Markets globally continue to show strong risk-seeking behavior, a continuation of the broader trend in place for much of the time since late March 2020. That was the point at which monetary and fiscal policy activity surged to produce enormous stimulus in the US and globally.

Recent US legislation that included a total of about $900 billion in new fiscal support is now starting to be felt, and recent political developments have increased the odds of further fiscal support this year. Alongside this persistent fiscal support to counteract the severe economic impacts of COVID-19, monetary policy remains extremely accommodative. Near-zero policy rates and heavy bond buying programs are expected to be maintained for many months if not years, putting both monetary and fiscal policy firmly in the “highly stimulative” category at the same time.

Negative sentiment on the dollar becoming extreme

One of the most notable trends in markets recently has been the weakness in the US dollar. After a choppy strengthening trend since early 2018 (as the Fed was tightening policy), the US Dollar Index surged in the immediate aftermath of COVID-19’s arrival in March. Since then, however, as monetary and fiscal stimulus engulfed markets and investor risk appetite returned, the dollar has been weakening versus a number of other currencies. Indeed, the dollar’s weakness has accelerated recently, and the Dollar Index has reached its lowest levels since May 2018.