Risk vs. Momentum
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As I look at the broader market right now, specifically the U.S. stock market indexes, I sense more risk than I did in September & October. As I’ve mentioned before, risk is a two-sided coin, defined as the probability of an outcome that you don’t expect. As such, an outcome could be better or worse than expected, hence why risk and reward are typically congruent. The higher the risk, aka the higher the likelihood of an unexpected outcome, the higher the potential reward/punishment. When I evaluate the condition of the market right now, I specifically see complacency & downside risk after 6 weeks up “up only”. Risk/reward is skewed to the downside, in my opinion, offering minuscule risk premium (the incentives & upside potential given to those who take risk vs. the risk-free rate of return).
Think about this:
As of Friday’s close, the Dow Jones has a YTD performance of -5.8%. In order to reach new all-time highs, it would only have to gain +7.6%! Considering that the index has gained +19.9% in the 31 trading days from 10/13 - 11/25, it’s clear that the market can produce substantive gains in a brief period of time.
The +7.6% currently required to reach new ATH’s was instead +28.6% at the open on 10/13. Risk in the market was extremely high on 10/13, and investors who decided to allocate capital around that time have been rewarded handsomely & quickly. Will investors who allocate today experience the same rewards? Perhaps in terms of magnitude, but certainly not as swiftly. Consider the chart below: