Equity Risk Monitors — September 7, 2021

Equity Risk Monitor Highlights | Week Ended September 2, 2021

  • Hidden risk may be lurking in the US
  • Emerging Markets increasingly riskier than Developed
  • Asset diversification soars as trading volume tanks

Hidden risk may be lurking in the US

As the US equity market continued its upward march last week, the spread between statistical and fundamental risk forecasts widened, sounding alarm bells about non-traditional risk sources lurking under the surface. US indices reached new records last week ending Thursday, following Federal Reserve Chairman Jerome Powell’s comments and positive economic news. As the market rose, both statistical and fundamental variants of the US short-horizon model trended downward, but the statistical forecast remained well above the fundamental outlook.

The risk spread between statistical and fundamental forecast has been widening since June, when the short-horizon statistical and fundamental variants of the US model were in accord. The statistical variant reported a level of risk that was 2.6 percentage points higher than its fundamental counterpart last week—nearing the five-year record of 3% seen in May. A similar pattern was observed at the median horizon. While still positive, the medium-horizon spread was narrower than at the short horizon. The widening of the risk spreads may reflect potential changes in the risk regime and/or the emergence of non-traditional factor risk sources in the US.

See graph from the United States Equity Risk Monitor as of 2 September 2021:

Emerging Markets increasingly riskier than Developed

Emerging Markets have become progressively riskier than Developed Markets in 2021, after starting the year at parity. Emerging Market risk continued its August surge, while Developed Market risk was slightly down over the past five days, as reflected by Axioma’s Emerging Market and Worldwide short-horizon fundamental models, respectively. The ratio between the short-horizon risk of STOXX Emerging Markets 1500 and STOXX Global 1800 spiked last week, reaching a year-to-date peak of 1.4. That is, Emerging Markets were 40% riskier than Developed Markets last Thursday, or about double the 20% median of additional risk typically seen by Emerging Markets vs. Developed Markets. The risk ratio is now approaching levels last seen at the height of the Covid-19 crisis in February 2021.

The chart below does not appear in our Equity Risk Monitors, but can be provided upon request:

Asset diversification soars as trading volume tanks

Asset diversification soared worldwide, as markets continued to rise on relatively low volume. Asset diversification in the STOXX Global 1800 index climbed to new records last week, indicating that portfolio managers are in the best position to diversify their portfolios in roughly a year. The asset diversification ratio is calculated as the weighted average asset variance for each stock in the index, divided by the total forecasted index variance, and measures the impact of correlations on total risk.

Trading activity for the stocks in the STOXX Global 1800 index surged in the first three months of this year, before plunging in April and remaining on a downward trend ever since. Trading volume dipped to a new year-to-date low (below $300 billion) last week. While possibly attributable to the end-of-summer lull, the low trading volume may reflect investors’ skepticism, even as positive news is driving the market higher.

See graphs from the Global Developed Markets Equity Risk Monitor as of 2 September 2021:

For more insights and research from the Applied Research team, please click here.