GOLDMAN SACHS: Market risk is at 'extreme' levels, and that raises a key question about the future

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• Market risk has reached its highest level in history, which calls into question future returns, says Goldman Sachs.
• The dynamic has been accompanied by the best-ever start to a year for stocks, while US Treasurys have been 2018's worst-performing asset, the firm says.
• Goldman argues that the macroeconomic backdrop is probably strong enough to sustain these risk levels for the time being, but other experts disagree.

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The market may have a risk problem.

With an index of global stocks off to its best-ever start to a year, risk appetite has reached its highest level on record, according to data compiled by Goldman Sachs. Those equity returns stand in stark contrast to US Treasurys, which have been the worst-performing asset so far in 2018.

Since government-issued bonds are generally viewed as the most risk-averse possible investment, while equities are on the top end of the risk spectrum, the divergence shows just how willing traders have been to throw all caution to the wind.

The risk appetite is "extreme" and "leads to questions about future returns," a group of strategists led by Ian Wright wrote in a client note.

This chart shows Goldman's indicator, which assesses total global risk across all asset classes.

Goldman Sachs Global Investment Research

So is it time to start screaming for the hills? Not quite, says Goldman. The firm argues that signs of economic strength have overruled stretched risk thresholds in the past.

"While high risk appetite increases risk of disappointment, we find historically that the signal from macro data tends to trump the signal from risk appetite," said Wright. "We think this will be the case again now."

The firm reiterates its overweight position on stocks, and its underweight view on bonds, for both 3- and 12-month time horizons. It cites "good growth, a solid macro backdrop, and our expectation of tighter monetary policy."

But just because Goldman is fine with the market's thirst for risk doesn't mean everyone else is. There are many other market experts lamenting the devil-may-care attitude being exhibited by investors.

That includes financial services firm INTL FCStone, which warned late last year that money market assets are at a record low 17% of long-term funds, while the cash balance of equity mutual funds also sits at an all-time low of 3.3%.

"A decade of financial repression has turned cash into trash," the firm's macro strategist Vincent Deluard wrote in a recent client note. "There is not much sidelines cash left to push stocks higher."

It's clearly a development that's on the minds of many, with TD Ameritrade CEO Tim Hockey saying on Tuesday that he's never seen client cash levels so low.

While that sort of full market participation certainly shows that traders are engaged and active in the market, it also suggests that they're running out of investment ammunition. At this point, it remains to be seen whether this will stir up problems for the broader market, or if macro factors will prop it up, as Goldman suggests.

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