I’ve never been a huge fan of the terms risk-on and risk-off. They can be convenient shorthand for describing broad market trends on an intraday or short-term basis, but they lack subtlety. Despite my general lack of enthusiasm for the terminology, “risk-on” seems to be an appropriate term for equity markets over the past few days.
But there’s been a major change in the character of these moves: risk-on days typically saw money flow from bonds into as stocks. Risk-on days saw yields rise as investors sold bonds and bought stocks with the proceeds. That made perfect sense if investors were fully invested and carrying little cash.
Now we are seeing bonds move along with stocks on risk-on / risk-off days. The current rally has been accompanied by – or predicated upon — falling interest rates. This implies that money is flowing in and out of cash rather than allocated between assets.
When we consider that institutional investors in both bonds and stocks have been raising cash in order to de-risk their portfolios, the latter approach makes sense. If they want to add risk, they need to deploy that cash to purchase the types of assets they manage. Hence, a risk-on day involves higher bond prices (lower yields) and higher stock prices.
One hallmark of the risk-on/risk-off approach remains the same. Risk-off markets typically were accompanied by dollar strength, and vice versa. The US Dollar is perceived as a bastion of safety, so nervous investors flock into the dollar when they are nervous, and out of it when they are more sanguine. The dollar has been giving back some of its recent gains against major currency counterparts like the pound, Euro and yen. In August we wrote that the stronger US dollar would act as a headwind for the multinational companies that dominate major US indices. We heard that yesterday from the second largest US company, Microsoft (MSFT). It is quite reasonable for investors to buy US stocks when the dollar eases against its peers.
I believe that the ascension of Rishi Sunak to the UK Prime Minister role plays a large role in the recent risk-on mindset. The near-meltdown in gilts that occurred just before the end of the third quarter was deemed to have been caused by an adverse reaction to tax policies promoted by former PM Liz Truss. The events revealed serious cracks in UK pension funds sufficient to require intervention by the Bank of England. The new PM brings an air of stability, and with that we have seen gilt yields and the pound recover to levels that prevailed before Ms. Truss took office. The anticipated 75 basis point hike from the European Central Bank and some well-timed (rumored) intervention by the Bank of Japan added stability to those currencies as well.
Imagine if I told you prior to today that MSFT and Alphabet (GOOG, GOOGL) would be down about 6% each, along with Apple (AAPL, -0.5%), Amazon (AMZN, -1.75%) and Meta (META, -2.6%) all trading down, yet the NASDAQ 100 Index (NDX) would only be marginally lower. You would have found that unlikely, if not implausible. But that is how we find ourselves as I write this around midday. We can debate why investors have become so sanguine so suddenly – hopes for peak rates, FOMO, or
something else entirely – but they are certainly willing to assume risk across a wide range of asset classes.
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