Risk On / Risk Off Is Nonsense « Fisher Investments Investing IQ

Tuesday 24 May 2011


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 This burgeoning concept of “risk on/risk off” trading is nonsense—it’s the notion that when markets are down, XYZ falls the most because it’s “riskier”; when markets are up, the same XYZ will be up more for the same reason. Whenever I hear this logic I envision an expansive floor of traders pulling levers “risk” or “risk off” on their Rube Goldberg machines, making trades like automatons all day.
One of many problems with this concept is defining what “risk” and “risk off” actually is. for instance, ostensibly last week was a “risk off” week tied to down markets on major geopolitical events (Middle East unrest and the Earthquake in Japan ). Of course, Japan was down more than just about any other country. So I guess that means it’s a “risk” asset. but since when was Japan considered riskier than, say, Europe ? And what about those PIIGS? Those are clearly “risk,” right? Nope. They largely held up fine last week, which I guess makes them “risk off?”
And then there’s the US . you know, the epicenter of financial crisis? That’s pretty much officially “risk off” too at this moment, but used to be major mondo “risky”, from what I’m told. And US Treasuries? Those are still more or less seen as “risk off”, but I find that ponderous considering the historically low yield environment—isn’t the risk substantial that rates pop up in the intermediate term and crush prices? I’d despise to be holding on to a bunch of 10 years with high convexity on the notion that bonds are “risk off.”
If all this seems confusing, it should be. because risk on/risk off is a myth. this is all really about an assessment of relative fundamentals at any given time, not some (seemingly) arbitrary category assignment. Fact is, what’s considered risky and less risky can change, and rather abruptly and violently. Here’s a much better explanation about how trade activity might often work: Herds on the Street. (If you haven’t read much Johah Lehrer yet, you should.)  That’s it from my desk here at Fisher Investments.

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