Photo: Goldman Sachs
Earlier this morning, SocGen’s currency guru Kit Juckes wrote that he believes that the “risk on/risk off” trade would come to an end this year.”Risk on/risk off” is when risky financial asset classes move in unison based on market-moving news. In other words, correlations across asset classes are high, a phenomenon that occurs when volatility and uncertainty are high.
Like Juckes, Goldman’s Jim O’Neill comes to a similar conclusion based on observations he has made in the currency markets.
From his latest Viewpoints note:
There are a number of growing hints that the post-2008 environment of “risk on/risk off” with very strong cross-asset-class correlations is reversing. If this were true, it should be really good for specific investors who can concentrate on their asset class and not worry so much about extraneous forces. I had already touched on this a number of times during 2012, not least because smart investors should try to anticipate these trends reversing before the masses. But now, the evidence is accumulating.
It is at its most apparent in the foreign exchange market, with the dramatic decline of the Yen since mid- November, which is clearly a function of the incoming LDP leader Abe planning for a more activist set of policies. Many sell-side commentators are still focused on the two-year US-Japan interest rate differential in following the Yen, which worked so well since 2008, but – at least for now – has clearly broken down. I would remind people that over a longer period – in fact, since the early days of floating – there is very little statistical evidence that US-Japanese interest rate differentials are that crucial for USD/JPY.
Since the start of 2013 – and this is potentially dangerous to conclude as permanent – the Euro has declined, despite a strong rally in asset markets, including a continued powerful rally in peripheral European bonds.
Then there is the ongoing softness of the Gold price that I talked about in my Viewpoint from 21st December, which the bulls will simply pass off as year-end positioning squaring and noise. However, if – as I shall discuss now – it is part of a re-emergence of equities and the end of the bond obsession, then this could be curtains for Gold.
Here’s a chart from JP Morgan that shows the long history of correlations in the stock markets and the periods of volatility during which they occurred.