Monday, September 12, 2011

Thirteen Ways of Looking at Risk

I do not know which to prefer,
The beauty of inflections
Or the beauty of innuendoes,
The blackbird whistling
Or just after.

With triskaidekaphobia on all our minds here at the home office of my Risky Business -- even though it is a day early -- I believe there will be no official action taken to revoke my creative license because of the apparent headline claim that we have only 13 ways of looking at risk in the equity market.

In fact, I think we have an infinite number of ways of looking at risk in the stock market.

One of them centers on New York Stock Exchange (NYSE) securities-market-credit data, which our droogies there report monthly.

For the months between January 2003 and July 2011, the NYSE reported these data via three discrete series: Margin Debt, Free Credit Cash Accounts, and Credit Balances in Margin Accounts.

Drawing on these three data series, I have developed a comparative and dynamic measure of equity-market risk, which is brought up-to-date each month and known as the Securities Market Credit Risk Rank (SMC Risk Rank).

A high SMC Risk Rank indicates the stock market may be close to a significant peak, and a low SMC Risk Rank suggests it may be close to a significant trough. In my interpretation, the term close in this context means within three to six months. Therefore, I consider this metric most useful not tactically (i.e., in positioning for the short term) but strategically (i.e., in positioning for the long term).

Following are current tables showing the six months with the highest SMC Risk Ranks and the six months with the lowest SMC Risk Ranks:

Highest SMC Risk Ranks
(As of July 2011)

Source: Risky Business Analysis and Table Based on NYSE Data

Lowest SMC Risk Ranks
(As of July 2011)

Source: Risky Business Analysis and Table Based on NYSE Data

Based on my reading of these tables and their underlying data sets, I believe the equity market had been cruisin' for a bruisin' since the first quarter of this year. Moreover, I think the SMC Risk Rank of 28 for last July may mean the masters of the universe -- I mean, the margin clerks of the world -- may have more work to do as stock-market participants move from being overleveraged to being underleveraged.

As a risk-management measure, I therefore have my crash helmet, chest harness, and seat belt all securely fastened.