Investor Risk Appetite: A Decade in the Red?

The state of investor risk appetite is a crucial indicator for understanding market behavior. In recent years, it's been remarkably low – perhaps even worse than any period in the last 30 years. This "secular funk," as some analysts call it, is reflected in the way investors have de-risked their portfolios over the past decade, the valuation gap between safe and riskier assets, and a pervasive fear of Black Swan events.

Measuring Risk Appetite: A Complex Equation

Several factors contribute to measuring risk appetite. One key indicator is credit risk appetite, which measures how much investors are willing to lend money and take on potential losses. In the US, this measure has recently surged to a 10-year high, suggesting a shift in investor sentiment. However, global risk appetite remains below its previous peak and requires further monitoring.

The Euphoric Cycle: A Warning Sign?

While credit risk appetite is showing signs of improvement, equity sentiment indicators are already reaching alarming levels, even after just three weeks into the new year. This raises questions about whether we are heading towards another euphoria episode, similar to those seen in 2006. Such episodes can be followed by sharp market corrections, highlighting the importance of careful risk management.

A Recipe for Crisis? Examining Risk Appetite Indicators

Research analysts have developed models to predict major market crises based on factors like asset valuations, leverage, and risk appetite. These models suggest that a combination of extreme overvaluation in major asset classes, high leverage in both the real economy and financial system, widespread risk appetite euphoria, slowing global growth, and tight monetary policy could create the perfect storm for a crisis.

Navigating Uncertainty: A Cautious Approach

Given the complex interplay of factors influencing market risk, investors should adopt a cautious approach. While opportunities may exist, it's crucial to carefully assess potential risks and consider diversification strategies. Continuously monitoring key indicators like credit risk appetite and equity sentiment can provide valuable insights for making informed investment decisions.