There are a limited number of “risk on” indicators we are following. Among those, the 4 discussed in this article are among the key ones: 2 are focused on the stock market (U.S. specific) and 2 are intermarket based.
In the stock market, the consumer discretionary to consumer staples ratio is an important risk on / off indicator. As the long term chart shows, the ratio is still in an uptrend, one that started in late 2009. After a false breakdown in August, the ratio is in a “safe zone” currently.
Furthemore, in the stock market, the Dow Jones Transportation Index has dipped below the 90 WMA (the only moving average we are following to determine long term trends) in April of this year, and could be consolidating right below it. There is a bullish case to be made that the pattern is similar to the one in 2011/2012. However, there is also a bearish case, based on the fact that current consolidation is taking place BELOW the 90 WMA, and that we are right at support currently. So there is no clear direction at this point yet, but we believe this situation will resolve soon. Watch 7500 points at the downside and 8200 at the upside.
An indicator to measure risk appetite in the market is the ratio of the High Yield Corporate Bond vs 20 Yr Treasury Yield. A rising ratio points to a “risk on” mood. As the next chart shows, a big triangle formation is in the making, and it will likely resolve somewhere in 2016. A break above the resistance line would indicate “risk on” while below support would point to “risk off”.
From an intermarket point of view, the 30 Yr Treasury Price vs the S&P 500 is a good indicator for risk preference: the lower the ratio, the more investors are willing to take on risk. A HUGE downtrend was broken recently, and as the below chart shows the ratio is testing its downtrend. In other words, investors are making up their minds whether they want to go back in “risk on” mode or prefer “risk off” with longer term bonds.
Our 4 risk indicators have a bullish bias, but we are nearing a huge inflection point. Those indicators need to be watched closely in 2016 as they can help in identifying a confirmed trend.