Monday, December 17, 2012
Risk-On Risk-Off Risk Undecided
I’m hearing from lots of traders that they’re getting “chopped up” in the post QE3 markets. They’re not alone. The world of managed money is doing no better. Institutions and hedge funds are telling me and my colleagues that it’s all they can do to hold onto gains made earlier in the year.
The “sure things” like Apple and Google have taken hits recently. The lovely uptrend that lasted from the June lows until just before U.S. elections has given way to a choppy sideways market that is just enough volatile to take out stops on swing trades for both the long and the short sides. Basically, things have gotten ugly for those trying to find “outperformance” or alpha in this market.
What’s more striking is that the “risk on” vs. “risk off” paradigm has not been working. Back in May and June of this year, I wrote an article series on how this phenomenon had changed the way institutional traders look at the market. In essence, portfolios and trades were being swung from “risk on” (things that work well when markets are moving higher) to “risk off” (those instruments that are relatively better in down markets) in an almost binary or yes/no fashion.
Risk On / Risk Off becomes “Risk Undecided”
One of the pages that I keep in my charting package is labeled “Risk On – Risk Off”. It contains a series of charts that track the ratios of classic pairs of risk on vs. risk off assets. I thought it might be instructive to give you a glimpse of what I’m seeing when I looked at those charts as of the close of Monday (12/10). Let’s start with Small Cap stocks, represented by the Russell 2000 (risk on) vs. the large cap stocks of the S&P 500:
The chart is fairly self explanatory – risk on asset at the top, risk off asset in the middle, and the ratio of the two at the bottom. When the ratio heads up, that indicates risk on behavior. The ratio dropping equals risk off. For almost two weeks the ratio has been going sideways telling us “risk undecided”…
In the bond world, when we look at riskier (high yield) bonds vs. U.S. Treasuries, we see a similar picture:
Once again, we see that neither side can gain the advantage. How about on the currency side? The classic combo is the Australian dollar for the risk on side vs. the Japanese yen for risk off:
Let’s look at one last chart – silver (higher risk) vs. gold (lower risk):
We can see that after silver gained some ground on gold, the ratio has been flat since late November.
For the past several weeks, all of these charts indicate similar behavior: there has been no flight to quality, nor has there been any desire to jump into the riskier asset.
What Does It Mean?
We’re in a market that can’t decide which way to go. Perhaps a resolution for the much discussed fiscal cliff will give the market some directional movement. But until then, the market doesn’t want to pick sides between the various risk assets. Unless you have some keen insight into where the fiscal cliff debate will end up, this may be a good time to keep your powder dry.
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