“Risk on, risk off” is a phrase used to denote the massive trading shifts taking place at institutional levels in the post-GFC (“global financial crisis”) world. The phrase encapsulates the skittish approach investors have taken to the day-to-day news and data feeds that are highlighted on the evening finance news segment. The question for us is, “do you want to play the game?” Well, do you?
Risk On Risk Off
Risk on, risk off is an outcome of a great many variables and inputs, as well as the usual fear and greed that are so necessary for a capital market to move to an efficient equilibrium. However, modern technology and communications mean that every person with a phone has immediate access to the latest comments by the head of the European Bank or The Fed or anyone else in the public eye. If you want to see what triggers some “knee jerk” reactions from investors, just have a look at the current screen snapshot from one of the websites most watched by the worlds financial people – “Bloomberg.com”
Risk off is a move out of growth assets and into “defensive assets”. What are defensive assets? They will generally be fixed income securities or cash. Globally, this can be seen when a large wave of money “heads for the exits”. That is, money is stashed into cash areas.
That cash is most readily identified with US Treasury Notes and US debt markets. This correlation is a function of the enormous size of the US debt trade. Billions of dollars can literally be invested or redeemed in a single day in this market – something that simply cannot occur efficiently in most other markets. “Efficient means without impacting on the market itself – it doesn’t help to be able to redeem your money if in the process of doing so you cause the price to drop dramatically. These markets are some of the most “liquid” in the world, and being able to get your money quickly and efficiently is what makes more risky trading strategies less risky.
I’ll share with you a chart that shows how the “Risk Off” trade occurred so very abruptly leading up to and after the US election, when it became clear that no-one was elected with sufficient numbers to be able to ram through their legislative preferences. In other words, the US economy is back in the hands of a group of bickering characters, who can’t see past their own self interest to the good of the country. Look at this chart and the latest move in interest rates on US 30 year debt. Given the size of that pool of money, it takes a large wave of cash buyers to get the rates to fall that much so quickly. This is Risk Off.
That final leg down has been quite direct, hasn’t it? It could be worry about the Greek government ability to convince the Eurozone that it is achieving results sufficient to keep it from going bankrupt or it could be worry about Chinese imports or Japanese failure to generate growth or a combination of all of these.
Risk on is a move back to “growth assets”. This means property and shares mostly. A move to risk on can be triggered by a drop in interest rates. It could be triggered by expectations of or confirmation of another round of QE or money printing by the major central banks. The end result of a “risk on” trend is a movement out of cash and income securities, and into share, property, commodity and currency markets.
Risk On Risk Off – why so quick?
“Risk” is such a beguilingly simple term. Believe me, it is anything but simple. Here are some of the reasons that the movement in markets results in a “risk on risk off” swing cycle:
- Asset allocation changes – large super and pension funds have traditionally operated off reasonably static allocations between cash, shares, property and other assets. However, the large swings in markets since the GFC feed a need to change these allocations more often in order to “keep up with the Joneses of the super world”. This means that very large amounts of money will react quickly and often in concert, as different triggers of worry cause similar reactions across many portfolios.
- The need for short term performance – many people choose a super fund or an investment fund simply on whoever has the “best” performance in the recent past. This means a funds’ opportunity to attract new business and grow is linked to its investment performance every single quarter (most of the larger surveys of comparisons are done quarterly).
- A move to more “alternative” investments. This is one of the great farces of the post-GFC environment. To obtain a “less volatile” return, many large super and pension funds have increased their allocation of money to hedge funds and trading strategies that generate returns by speculating on volatility (any reasonable hedge fund will argue with my use of the term “speculating”..). Therefore, more volatility causes more money to go to areas that speculate on more volatility, causing more volatility.
- High Frequency Trading – or HFT. This is proof that many “sophisticated” market improvements really just result in greater volatility and less transparency. The high prevalence of HFT means that any core risk on, risk off trading is exacerbated by the massive flow of trades trying to take advantage of minute movements in market pricing.
In reality, most mainstream discussion on investment is not discussion at all. It is fear-mongering and a regurgitation of last years results as the next decades most likely outcome. It is no wonder that people are torn between greed and fear.
A Quick Profit
Aussie’s love a bet. You can’t stop a bloke from betting his mate that his dog is tougher than the other (extrapolate to your own version of high brow/low brow as required). Similarly, having a story about a quick profit is a great social points getter at the weekend barbeque. When you look at risk on risk off, it can seem as though all you have to do is to buy on the drops and sell on the rises. If only it were that simple. The desire for a quick profit also pervades the risk on/risk off market movements. In those cases, it’s not about asset allocation or long term capital growth or income objectives, it’s about the stark choices of speculation on very short term price movements. Risk on risk off is very much a result of the actions of people treating a market set up for companies to raise capital, as a betting ring. There’s no problem with you or i participating – but we must never make the mistake of thinking we are investing when all we are doing is perching ourselves on the edge of the Kalgoorlie two-up ring, holding a fist of $20 bills and yelling out “tails! 20 tails!”