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The Daily RAG

(Risk Appetite Gauge)

Democratising professional trading intelligence. This 1 - 2 week view on the outlook for risk assets is published each trading morning by email before 9:30 am London time.

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“The product is entirely different, and better than anything produced by the sell side” ... “often uncannily right” - Mike Sullivan, Chief Investment Officer EMEA, International Wealth Management Credit Suisse

What (really) moves markets?

Over the long term (beyond a six month time frame), stock market movements are driven by a combination of fundamental factors. Those include liquidity, economic and earnings growth, and shocks.

Over the medium term (a one to six month time frame), sell offs in the stock market are typically brought about by overly optimistic enthusiasm towards risk assets. That excessive optimism can be seen in positioning in portfolios that is overly biased towards risky assets (i.e. higher beta, higher volatility assets, like most equities). A subsequent normalisation then generates a sell off.

Over the short term (up to two weeks) the behaviour of markets is dominated by fear and greed. This is the timeframe over which the Daily RAG provides incisive insights into market direction. Last year our subscribers enjoyed a positive recommendation hit rate of nearly 70%! Newsflow is often used to explain the movement in prices and, at a micro level, that is often the case. Good earnings can push a stock higher. A bid for a company will also similarly move a share price dramatically higher, while a profit warning can achieve the reverse. For the market as a whole, though, the factors that can single handedly move the major equity indices are few and far between: Surprise announcements of central bank stimulus or tightening can change stock market trends; the surprise election of new governments with radical new agendas can fuel a stock market’s rally; while major natural disasters can also impact the near term trend of markets (e.g. Fukushima nuclear disaster, Hurricane Katrina in New Orleans). Above and beyond those factors, though, the short term movements of the stock market are primarily dominated by ‘fear and greed’.

Our RAG models measure fear and greed in global financial markets. We use those models as our primary input into making short term 1 – 2 week recommendations on equity indices. Typically we aim to lean against the prevailing sentiment, once we judge it as having become too strong in one direction or the other. For example, when the market is fearful, it pays to be greedy (long major equity indices). When the market is greedy, it pays to be more cautious and either remove the long positions or go short equity indices.

We complement our risk appetite gauge (‘RAG’) models with further research to reinforce our recommendations. For example, we also use models which measure downside put protection in portfolios, while a variety of volatility models can contain interesting and insightful information, as can certain technical models. We use these and other models to help confirm/challenge our understanding of the short term market environment, as determined initially using our risk appetite models.

Introduction to the Daily RAG from the CEO