- An increasing number of experts across Wall Street are warning that the ongoing market and economic cycles are entering their final stages.
- One statistic compiled by Morgan Stanley (NYSE:MS) suggests investors are already getting more risk averse, which could usher in the end of the cycle even more quickly than previously thought.
As the prospect of a trade war threatens to divide the world, a unified front is forming in global markets. It's just not the type any risk-seeking investor wants to see.
A Morgan Stanley gauge that monitors the correlation between asset classes and geographic regions has spiked to its highest level since 2016. This implies that financial assets around the world are trading more in lockstep than at any other point in recent memory.
Perhaps more important for those seeking market signals, it also means investors are shifting into risk-off mode — one that could be setting in for the long term. And it's a definite warning signal for the risk-hungry traders still scouring the landscape for yield.
Tim Emmott, the executive director at Olivetree Financial, takes it a step further by suggesting that cautious investors are bracing for the possibility of a market meltdown.
"The fact that this index is trending higher currently could well be the true signal for market players to realize that current multi-asset moves toward risk aversion may be more than short-term," he wrote in a note reviewed by Bloomberg. "The move in correlation here may be the canary in the coalmine for the medium-term trajectory of real systemic risk to markets."
To fully appreciate what's at stake as global cross-asset correlations surge, consider that tandem moves in stocks and bonds can throw portfolios out of whack by exacerbating volatility. This is particularly true for the models used by risk-parity and balanced mutual funds, which are designed to de-lever when price swings spike, according to Nikolaos Panigirtzoglou, a global market strategist at JPMorgan (NYSE:JPM).
As if that's not worrisome enough, Binky Chadha, the chief global strategist at Deutsche Bank (DE:DBKGn), recently pointed out that lockstep moves in major asset classes could portend contagion-driven weakness.
"The tight correlation in the moves across the major asset classes (oil up, dollar down, equities and bond yields up) suggests a pullback in one for idiosyncratic reasons would likely spill over to the others," he wrote in a client note earlier this year.
To Keith Parker, the chief US equity strategist at UBS, rising cross-asset correlations can be a sign that an economic expansion has entered its final stage. He told Business Insider back in March that he was closely watching the relationship between US stocks and bonds for recessionary signals.
In the end, if today's expansion is trudging through its final innings, it would seem to be a prudent decision for investors to start leaning toward risk-off positions.
But is it really time to pack it in and flee to safety? Any investor you ask is likely to suggest a different timeline for derisking. Some might urge you to seek shelter immediately, while others would be incredulous at the prospect of missing another leg of strength.
Regardless of where on the spectrum you fall, you'd be best advised to keep an eye on all these disparate elements. The signal you're looking for is probably there somewhere — and half the battle is knowing where to look.