Normally, the risk appetite indicator needs to register close to -2 before investors can expect a reversal in market performance without a change in the momentum of the wider economy or policy support. And while the indicator is currently well above that level, things can change quickly.
A good example was during the summer in 2024, when the risk appetite indicator fell to -2 in a matter of days after the start of the equity downdraft, creating a good buying opportunity for investors, who could look for a market recovery shortly after.
“Normally, when we have an equity correction, I’m looking either for the risk appetite indicator going to -2 or our equity drawdown risk model — which incorporates macro momentum, policy shifts, and also the risk regime — starting to peak. We don’t have either yet. And that tells us that, in the near term, things could remain quite bumpy,” Mueller-Glissmann says.
What’s the outlook for the 60/40 portfolio?
At the beginning of the year, when the equity drawdown risk indicator was suggesting an elevated risk of a correction in US stocks, the portfolio strategy team cautioned that investors should diversify portfolios both across and within assets. Diversifying across assets means balancing out equity exposure with bonds; diversifying within assets means investing in equities from non-US markets.
But Mueller-Glissmann adds that the 60/40 formula for buy-and-hold portfolios — comprised of 60% equities and 40% bonds — has continued to perform well so far this year.
“Equities are down in the US, but bonds have rallied in the year to date. And in Europe, bonds are down, but equities have rallied,” Mueller-Glissmann says. This means that an average portfolio comprised of both assets from either region was diversified enough to keep yielding returns in spite of the volatile start to the year.
How to invest amid signs of economic slowdown
Historically, it’s unusual for non-US equities to decouple from their US counterparts, Mueller-Glissmann adds. This means that a continued decline in US stocks could start to affect global equities more broadly.
“What tends to happen is, maybe on the first instance as US equities sell off for the first 5-10%, European and global equities can outperform, like they have for the last few weeks,” Mueller-Glissmann says. “But then, if US equities go through a larger correction, the rest of the world tends to catch down.”
“As a result of that, you now want to think about diversifying not just regionally, but also across styles,” he adds. In particular, this includes low-volatility stocks — equities from more defensive sectors, which tend to fluctuate less than the rest of the market.
In the first two weeks of March, low-volatility indexes in Europe and the US materially outperformed other stocks in both regions. This marks a break from a spate of poor performance from low-volatility indexes since the time of the Covid pandemic.
Optimism about growth recovering in the wake of the pandemic coupled with rising bond yields has weighed on defensive sectors, which tend to have more debt and thrive in less optimistic market environments.
Now, Mueller-Glissmann says, both of those factors are starting to work in favor of low-volatility stocks, “because the market is getting a bit less bullish, and bond yields have come down a bit — especially in the US.”
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