Investors’ propensity to take risk has surged to a 3-year high according to Morgan Stanley’s Global Risk Demand Index, and such has been this indicator’s break-out that they believe asset markets can keep rising even after such a surge has already happened. Basically — Don’t read it as a contrarian indicator.
Morgan Stanley’s proprietary indicator of risk demand, the GRDI,1 surged to new highs this week, registering +2.8, the highest seen since March 2009. The current risk rally now figures among the top 10 since we began tracking the index back in 1995. Fuelled by the prospect of additional QE reducing tail risks, this has been a broadly inclusive rally, with strong risk demand across asset classes.
In particular they believe stock markets can continue to rise. Historically, global stocks have rallied after surges in risk-taking:
Equity returns have generally remained positive in the period following a break of the 2.5 threshold. On average, the SPX returned 1% in the month following the threshold event, and strengthened further to a total return of 5% on a 4 month horizon. Exhibit 5 sets out the range of outcomes observed for the SPX in the period following a +2.5 read on the GRDI. The chart illustrates the highest and lowest value, as well as the range between the bottom and top quintile of values seen on a daily basis following the GRDI peak. The worst case, which sees a 20% drawdown, was the crash of 1998. The table in Exhibit 5 contrasts the performance of the SPX in the lead up and following the peak in St GRDI. The MSCI World index tells a similar story, with the rally, albeit tempered, continuing in 75% of cases.
While they’re obviously basing their view on a model, and yes we’re all suspicious of models, their view at least makes sense from a layman’s perspective as well. When people’s risk-taking surges, momentum alone can at least keep things going for a bit, even if ultimately everyone turns out to be wrong.
(Via Morgan Stanley, FX Pulse, Calvin Tse, 14 October 2010)