As the stock market stabilizes from the devastating fourth quarter of 2018, investors must be wary of brokers pitching "risk off" trades.
First, let's define "risk-on risk-off." It refers to changes in investment activity in response to global economic patterns, according to Investopedia.
During periods when risk is perceived to be low, investors tend to engage in higher-risk investments; when risk is perceived to be high, investors have the tendency to gravitate toward lower-risk investments.
The spike in junk bond sales so far this year shows that brokers are willing to load up their clients with riskier products, meaning that brokers and their Wall Street bosses believe that the risk the market saw at the end of 2018 when the S&P 500 stock index fell almost 14% is largely off.
This thinking is clearly dangerous for Mom and Pop investors.
The Wall Street Journal last weekend reported as much.
"Junk-rated bonds and loans are flying off the shelves again, easing recent worries that a credit-market freeze could harm the economy," according to the Journal.
Indeed, companies with below investment-grade ratings or junk bonds sold over $50 billion of bonds and loans over the last few weeks of January, breaking a dry spell that saw just $29 billion of speculative-grade debt sold in November and December of 2018, according to the Journal.
"After hunkering down during the difficult final months of 2018, investors in January found themselves with ample amounts of cash to buy new bonds," the Journal noted. "In many cases, they have been lured by enticing offers from companies considered relatively creditworthy in the pantheon of junk debt."
These risky trades followed the Federal Reserve's pronouncement that they are unlikely to raise interest rates for the foreseeable future. The Fed's view led to a large bounce in stocks in January 2019, making most investors forget the devastating correction in November and December of 2018 when most were fearful and getting out of the stock market, the Journal noted.
Even the volatility index, known as the fear gauge, is now at its lowest level since last October.
Investors are even buying stocks on margin again after margin debt sank more than $90 billion in the fourth quarter to $554 billion, the lowest level since December 2017, according to statistics from FINRA.
A market strategist at TD Ameritrade reported that the firm is seeing margin debt numbers come back as the S&P has rallied to start 2019.
Margin is when brokerage firms loan clients' money to buy stock. However, if the stock decreases in value, the brokerage firm typically demands that the client deposit additional money or securities into the margin account. If investors don't make the additional deposits, the broker can simply liquidate the securities and take the money.
Brokers are supposed to recommend that investors make suitable choices and not react to any market blips. Should a recession occur in 2019, which many economists believe is possible, junk bond investors and margin borrowers will be greatly exposed. Investment fraud lawsuits will likely follow.
Investors beware of calls from your broker touting the risk off trade. Stick to your financial plan and long-term goals.
Zamansky LLC is a New York law firm which represents investors in court and arbitration cases against securities brokerage firms and issuers. The firm may represent investors in cases against companies mentioned in this blog. Zamansky LLC also represents investors in arbitration cases against UBS and other brokerage firms regarding Puerto Rico bonds and UBS closed-end bond funds and other investments. UBS Puerto Rico Funds | Investment Fraud Attorneys
Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it. I have no business relationship with any company whose stock is mentioned in this article.