Risk on, Risk off! The common cry of trading floors around the world these days. Every new release of high frequency economic data and utterance of political theater seemingly inspires a new round of risk on, risk off trading. Over the past three years, these wholesale investment forces drive markets dramatically, confounding professionals and individual investors alike with how seemingly correlated markets have become. We've all seen those risk on days where virtually every asset class rises, including corporate bonds, high yield bonds, municipal bonds, commodities and of course stocks, of every stripe and color. The risk off days, show investors shunning every asset class and scampering into the safety of Treasuries to ride out the storm.
Ben Bernanke has been quoted on several occasions articulating his risk on argument. The Fed's ZIRP (the zero interest rate policy) is calibrated to coerce investors to move cash out of money market funds and from beneath the mattress into "risky" assets. And so, each new economic release is greeted by investors with a perception of how either the economy or the Fed will respond.
We can't help thinking, though, that investors eager to jump on the latest momentum trade are all too conveniently glossing over the word "risk". What's articulated as risk on becomes understood as long on. Bernanke is equally cavalier in the use of the term, positing that senior citizens who now earn .25% on their savings should be looking to extend along the yield curve or move into more risky asset classes in search of return.
Well, maybe, but let's pause for a moment on the word risk. Webster's defines risk as "peril: the possibility of loss or injury". In the investment world, what goes up in a favorable market fueled by Fed policy and election year politics, just might turn around and bite you in the behind. Markets that move in wholesale up or down and that are highly correlated with other asset classes, belie fundamentals and possess a weak foundation for growth.
