Good Morning. I have been in the business of the markets since I graduated college in mid-1980 and I have been managing "other people's money" since 1986. I have seen strategies, themes, fund types, and even asset classes come and go. But it wasn't until this year that I had heard the phrase "risk on/risk off" used.
In the old days, we used to call the idea of being in or out of stocks "market timing." Although the mutual fund industry did its darndest to try and debunk the idea by telling anyone and everyone that would listen that it was impossible to make money by "buying low and selling high" (insanity, right?) and/or reducing one's risk exposure when things get ugly, the concept seems to be all the rage these days.
Today's version of the game is indeed a little more complicated than it was 25 years ago (what isn't!). These days, "risk on" definitely means more than just being "in" the stock market. Today, complicated algorithms create baskets of trades that go together well when traders want to take risk in the markets and have another group of trades to put on if they want to take risk off. Heck Dennis Gartman even created two new ETF's using the "risk on" and "risk off" concept. The symbols are ONN and OFF.
While this stock market can, and often does, turn on a dime (or more appropriately a headline, a rumor, or data point), it appears that traders have once again flipped the risk switch to the "off" position this week. Yes, I am aware of the fact that it was just five days ago that the "risk on" trade had added +8.8% to the S&P in just 8 days - with the majority of that gain coming in just three sessions. And nine days before that, traders had lopped off -8.3% from the value of the S&P 500 index with a "risk off" trade. But this is the way the market works these days. One minute traders are full of hope that the leaders of the eurozone will be able to finally put the sovereign debt crisis behind them and the next, well; despair is the name of the game as it appears there is no solution available.
Make no mistake about it; risk aversion is the name of the game this week. Take a look at the action in the areas associated with "risk on" such as stocks, emerging markets, commodities, etc. and you will find an awful lot of red ink. Speaking of red ink, the euro is swimming in it right now. Given what has been going on in Europe recently, the euro had actually been holding up relatively well. Heck the FXE (CurrencyShares Euro Trust ETF) was well above the lows seen in the summer of 2010 when we were worried only about Greece. However, the support for the euro appears to have broken this week as the currency is now in a free fall.
A major part of the decline occurring in the euro has to do with the fact that EU leaders are unwilling to do what is necessary to stop the credit contagion. They continue to dither and toss around lots of ideas for solutions. But the bottom line is that promising not to borrow more than you earn in the future does absolutely nothing to solve the current problem of too much debt and not enough income to pay for it. And then when you take away the ability to refinance that debt, well, you've got a problem on your hands.
Consider this; Greece has more than €20 billion of debt coming due on March 20, 2012. So I ask you, after what Greece is attempting to do to the investors holding €200 billion (and by the way, that much ballyhooed debt exchange isn't going so well), is anybody except the IMF going to lend them money? Next up, consider that according to CNBC, Italy and Spain alone have a total of €146 billion in debt that must be refinanced in the first quarter. Oh and the total amount of debt the eurozone will need to refinance in Q1 2012 is close to €750 billion. Remember, that's just the first quarter.
Okay, enough of the macro woes. Another reason traders have been flipping the switch this week is concern about earnings in both this quarter and next. Over the past week or so we've heard some pretty big names such as Intel (INTC), Altera (ALTR), Texas Instruments (TXN), and DuPont (DD) all tell us that things aren't going particularly well right now and that we should reassess our expectations.
And finally, we're also hearing about forced liquidations again. The bottom line is this market is as hard as anything most investors have ever seen. It is incredibly easy to lose money and gains tend to be fleeting. As such, there is lots of talk about so-and-so fund closing its doors. In short, this is yet another reason why traders are flipping the switch. Nobody wants to get caught in the type of downdraft seen in gold right now, so why not just flip over to the "risk off" position?
Turning to this morning ... Although PMI's in Europe and China showed economic weakness continues globally, Spain's 5-year bond auction put traders in a better mood as the auction saw decent demand and yields fell 1.2% on the 5-year bond. Thus, it would appear that the Risk switch will flipped back to the "on" position at the open.
On the Economic front ... The Empire Manufacturing Index (designed to indicate the state of the manufacturing sector in the New York region) for December was reported at 9.53, which was well above the consensus expectations for a reading of 3.0.
The Labor Department reported the Producer Price Index (an indication of inflation at the wholesale level) for November rose by +0.3%, which was above the consensus estimate for a drop of +0.2%. When you strip out food and energy, the so-called Core PPI came in at +0.1%, which was below the consensus for +0.2%.
Finally, Initial Claims for Unemployment Insurance for the week ending 12/10 fell by 19,000 to 366K, which was below the consensus estimate for 390K and also last week’s revised total of 385k (from 381K). Continuing Claims for the week ending 12/3 came in at 3.603M vs. consensus of 3.643M and last week’s 3.583M.
- Major Foreign Markets:
- Australia: -1.22%
- Shanghai: -2.14%
- Hong Kong: -1.79%
- Japan: -1.66%
- France: +1.20%
- Germany: +1.28%
- Italy: +1.52%
- Spain: +0.88%
- London: +0.91%
- Australia: -1.22%
- Crude Oil Futures: +$0.73 to $95.68
- Gold: +$3.70 to $1590.60
- Dollar: higher against the yen, lower vs. euro and pound
- 10-Year Bond Yield: Currently trading at 1.901%
- Stock Futures Ahead of Open in U.S. (relative to fair value):
- S&P 500: +14.13
- Dow Jones Industrial Average: +125
- NASDAQ Composite: +22.63
- S&P 500: +14.13