Measuring Risk Appetite With BCI (by Biffermas)

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"Bond traders always have been considered the smartest guys in the room," says Beth Malloy, bond market analyst at in Chicago. "But they keep a low profile."

Risk appetite is critical for ongoing gains in equities. A curtail of risk among the market makers would result in several outcomes: a reversal in the greenback, a broad-based equity plunge, a drop in silver and lesser-grade bonds, lower oil prices, etc. There are several gauges of how frisky the market is feeling, including the gold / silver ratio, the QQQQ / SPY ratio, and the Barron's Confidence Index, among others. Today I'll focus on Barron's because it's derived from bonds, and gives a peak into how the largest and best capitalized traders are feeling about the current risk environment.

The Barron's Confidence Index is derived from a simple method: compare the relative performance of high-grade bonds versus riskier medium-grade bonds. When medium-grade bonds outperform on a relative basis the index rises, reflecting higher risk taking. This sets the macroeconomic picture for other asset classes as well.


Barron's Confidence Index performs best as a 10-year weekly chart, with a 50-week moving average used as a trigger. A firm break above the 50-week indicates risk is returning, and occurred at critical market bottoms in 2003 and 2009. Conversely, a firm drop below the 50-week MA indicates bear market conditions are likely, and last occurred in July, 2007.


A few notes: the timing signals are not pinpoint, they are often several months early or late. Also, a well-pronounced false signal was generated in 2004 as the market chopped sideways into early 2006. This era, which I call, "The Great Theta-Burn Era", resulted in whipsaws in most directional indicators. Despite these issues, trading counter to the readings of the BCI will typically lose money unless your time frame is adjusted to short-term.