Identifying Risk-On/Risk-Off modes in real time
Macro Insight
QuantCube explains how its Leading Economic Growth Indicator can be applied to identify Risk-On/Risk-Off modes
QuantCube’s Leading Economic Growth Indicator tracks early economic growth trends and reversals in real time at a country level. Rather than relying on the publication of official data which is time-lagged, it leverages alternative data in real time to measure the daily evolution of macro variables for GDP such as consumption, employment, and international trade data, captured over 30 days. As for all QuantCube indicators, it is available through QuantCube’s Macroeconomic Intelligence Platform at point-in-time without any revisions.
Exhibit 1 compares QuantCube’s Leading Economic Growth Indicator with GDPNow (a nowcast model provided by the Atlanta Fed). Since QuantCube’s Leading Economic Growth Indicator tracks data in real-time, ahead of official numbers or other nowcast models that rely on lagged official data, users can monitor macroeconomic regime changes in a much more robust way. For example, it is useful for identifying macro regime turning points, indicating the top or bottom of economic growth. The anticipation of those trends and turning points will enable users to develop financial applications such as asset allocation, fixed income allocation or equity sector rotation.
Anticipate financial market crashes
We have created Risk-On/Risk-Off modes based on QuantCube’s Leading Economic Growth Indicator. Firstly, when at least one of QuantCube’s Leading Economic Indicators for major global economies is trending positive, this suggests there is some economic growth expectation in the world. It therefore triggers Risk-On mode. If there is no economic growth expected globally, it triggers Risk-Off mode. Exhibit 2 shows how Risk-On and Risk-Off modes can be used to anticipate financial market crashes, illustrating the application of Risk-Off mode since 2016, including following the trade war between the US and China and the onset of COVID-19.
Applications of Risk-On/Risk-Off modes for asset allocation
Identification of Risk-On/Risk-Off modes is a valuable tool to determine optimal timing for changes in asset allocation, equity sector rotation or credit rotation. For example, while in Risk-On mode investors can benefit from selecting sectors that heavily depend on future economic growth such as cyclicals. Conversely, during Risk-Off mode, investors can benefit from selecting defensive sectors. Alternatively, we can employ a Minimum Variance Portfolio approach if there is a constraint to invest in equity only. Risk-Off mode can also be used to determine cash holding levels in asset allocation strategies, for example, increasing the weight of cash holdings during Risk-Off mode to avoid significant downside risks as the Risk-Off mode corresponds to limited economic growth expectations.
