Market Regime Indicator: Q1 2024

The Market Regime Indicator (MRI) is a proprietary macro indicator developed by the SSGA Investment Solutions Group (ISG). Based on forward-looking market information, it is designed to identify the level of risk aversion/appetite in the market. The factors utilized to generate the signal include implied equity and currency volatility, as well as spreads on fixed income.

The Investment Solutions Group uses the MRI as one of the inputs into its global tactical asset-allocation decision-making process.

The MRI is the result of over twelve months of rigorous testing by the Investment Solutions Group. The test results showed that the MRI tracked historical market stress events and trading strategies based on the level of outperformance generated by the indicator. By design, the MRI signal varies between 0% and 100%. On this scale, a high level is often characterised by market tensions, such as a significant increase in volatility and a drop in risky asset prices.

Market Commentary

Global equities rallied over the first quarter as economic data broadly surprised on the upside, raising hopes that a soft economic landing could be achieved. While geopolitical risk continued to rise, sentiment remained buoyant, with the MRI moving between Low risk and Euphoria regimes throughout the quarter.

The Implied Volatility on Equities factor entered the first quarter in Low Risk regime, with 2023 having closed with the S&P 500 achieving nine consecutive weekly gains for the first time since 2004. The signal remained stable for the first half of January, before a number of factors dented market sentiment and pushed the Implied Volatility on Equities factor higher into Normal regime. Rate cut expectations were a key contributor, as monthly Consumer Price Index (CPI) surprised on the upside in the US. Additionally, both Federal Reserve (Fed) Governor Christopher J. Waller and European Central Bank Chief Economist Philip Lane pushed back on market expectations for rapid rate cuts. Geopolitical risk also increased as the US and the UK carried out air strikes against the Houthi rebels in Yemen following attacks on commercial shipping along the crucial international trade route in the Red Sea. Finally, a number of proposed new Chinese gaming curbs saw Asian equities struggle, led by a sell-off in technology shares in Hong Kong. Fairly quickly, however, the factor moved lower — into Low Risk regime — as the S&P 500 moved to a new all-time high driven by the performance of the Magnificent 7.

February followed a rather similar pattern as the Implied Volatility on Equities factor remained in Low Risk regime for the first half of the month, despite hawkish messaging from US Fed Chair Jerome Powell and renewed concerns over the stability of US banks, as New York Community Bancorp raised their expected loan losses. Once again, it took an upside surprise in US CPI to shake equity markets and move the MRI higher into Normal Risk regime as core CPI reached its highest month-over-month value since May of 2023. The technology sector, specifically semiconductor heavyweight Nvidia, came to the rescue again, as better-than-expected earnings drove a rally in global equities, with US equities breaching all-time highs once more, while the Nikkei surpassed its all-time peak from 1989. This improved sentiment saw the Implied Volatility on Equities factor move back lower into Low Risk regime.

In March, the factor briefly moved higher into Normal regime as weaker-than-expected data threatened the soft landing narrative. However, it swiftly reversed again, with the factor moving into Euphoria regime as the surge in global equities continued, as markets latched onto comments from US Fed Chair Powell, who said that “it will likely be appropriate to begin dialing back policy restraint at some point this year.”

The Risky Debt Spread factor was unusually stable over the quarter, remaining in Euphoria regime from start to finish. Spreads tightened throughout the quarter as risky assets rallied, despite default rates moving higher and returning to long-term median levels. Spreads on US and European High Yield hit two-year lows in March, while spreads on Emerging market debt trended lower throughout the quarter.

The Implied Volatility on Currencies factor entered the quarter in Normal regime, moving to the cusp of High Risk regime in early January. The factor then quickly moved lower, entering Euphoria regime before the end of the month, as rate cut uncertainty appeared to diminish over the short term, with pricing for rate cuts gradually moving later in the year. By late March, markets were pricing less than a 50% likelihood that policymakers would deliver their first interest-rate cut in June, a significant change from the start of the year when the first cut was fully priced in by March. The Implied Volatility on Currencies factor closed the quarter in Euphoria regime.