The State Street Risk Appetite Index rebounded to 0.09 from 0.18 revealing a modest retreat in risk bias across the month of March back toward neutral (see Figure 1 below).
“In a month where most central banks continued to encourage hopes of interest rate reductions and where the Swiss National Central bank actually began its rate cutting cycle, institutional investors were reluctant to add to their holdings of risky assets. On balance our risk appetite index showed that investors remained risk seeking in equities, but remain hesitant in fixed income despite the coming rate reductions. And the fact that risk appetite was completely balanced in FX and commodity linked assets shows that even with equity markets at record highs, institutional investors are still wary of the most cyclical assets” noted Michael Metcalfe, Head of Macro Strategy at State Street Global Markets.
The State Street Holdings Indicators showed that long-term investor allocations to equities rose by 0.6 percentage points to 53.4% (Figure 2 below), this was funded by a similar percentage point fall in cash holdings to 19.0% and a tiny 0.1 percentage point rise in fixed income allocations to 27.5%.
“Perhaps the biggest reason for investor caution going into the second quarter, is that institutional investors’ allocation to equities is within a whisker of its pre-GFC high. At the same time allocations to cash are within 0.3% of their long-run average; ‘excess’ cash levels relative to average at least are now close to exhausted, just as equity holdings reached their cyclical high. Good macro or micro news will be needed from here, over and above simple momentum one would assume, to tempt investors to actively underweight their cash holdings when yield levels are so attractive”. added Michael Metcalfe, Head of Macro Strategy at State Street Global Markets.
About the indicators
The Institutional Investor Indicators (the three i’s) were developed at State Street Associates, State Street Global Markets research and advisory services business. They measure investor confidence or risk appetite quantitatively by analyzing the actual buying and selling patterns of institutional investors derived from State Street’s USD42trn1 in assets under custody and administration (note not investors’ balances held at State Street itself). The Risk Appetite Index is derived from measuring investor flows in twenty-two different dimensions of risk across equities, FX, fixed income, commodity-linked assets, and asset allocation trends. The index captures the proportion of the twenty-two risk elements that saw either risk seeking or risk reducing behavior. A positive reading suggests that on balance investors are adding to their risk exposures, while a negative reading suggests risk reduction. State Street’s holdings indicators capture the share of investor portfolios allocated toward equity, fixed income and cash going back to 1998.
+++
Region specific comments, by Michael Metcalfe, Head of Macro Strategy, State Street Global Markets
Global / North America
Institutional investors hesitated in March. Fed rate cuts may still be coming even if fewer are expected in the long-run, but equity holdings are now close to a 15-year high and cash holdings are back to average levels.
Without “excess” cash holdings to be dragged back into markets by a combination of momentum and FOMO, it looks like Q2 will need to deliver a genuine improvement in fundamentals, macro or micro, for the rally to continue.
As has been the case for much of the past year the biggest threats to the US outlook remain either a resurgence in inflation or a resumption of recession risk. For now we note that investors seem to be betting on neither; institutional investor demand for TIPS weakened further in March, while borrowing of cyclical stocks relative to defensives remains unusually low.
Europe
The outlook for the Eurozone is much softer than the US but because of that is a little less uncertain. The ECB has guided firmly that rate cuts will begin in June, even if the central bank claims to be data not date dependent. Weaker economic data from here only reinforces more monetary support and this is beginning to be reflected in demand for Eurozone assets. Institutional investors stopped selling the Euro in March for the first time this year and in some European countries at least demand for equities is returning.
In contrast to the crowded positions in US equities and US tech in particular, European equities may prove themselves less vulnerable in Q2 if the overall allocation into equities begins to stall near its 15-year highs.
APAC
Risk appetite may have hesitated in aggregate in March, but continued demand for emerging market equities and Chinese equities remained a bright spot. Foreign demand for Chinese equities is now at highest point since the turn of 2023 when re-opening hopes peaked. This suggests that the series of policy easings, coupled with the restatement of the growth target have impacted investor confidence.
Foreign demand for Japanese equities in contrast has been more volatile this year in face of speculation about the timing of the BoJ’s first tightening. Now that this has come and gone without the feared appreciation of the JPY, it will be interesting to see if foreign demand for Japanese equities resumes again in April, after selling in March.
