Tags: Charles Hugh Smith | risk | stock market | investors

Financial Author Charles Hugh Smith: Time to Switch From Risk-On to Risk-Off

By    |   Monday, 15 September 2014 02:17 PM

How can investors tell when they should do an about-face with their risk-on strategy in the stock market and move to a cautious risk-off strategy? Financial author Charles Hugh Smith counts up the ways on his Of Two Minds blog.

First, he noted, junk bond yields are hovering at record lows, approximately the same level they hit the last two times those risky instruments reversed course in extreme moves, in 1999 and 2007. "The market for high-yield bonds is a well-known canary in the risk-on coalmine."

Second, Smith, author of Get a Job, Build a Real Career and Defy a Bewildering Economy and An Unconventional Guide to Investing in Troubled Times, said the sharp ascent of the U.S. dollar could become an ominous sign of things to come. "Without going into detail, it's increasingly clear that the soaring U.S. dollar is destabilizing the global foreign exchange markets." He said foreign currency trading has underpinned many risk-on carry trades in recent years.

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Investors are also ignoring the looming impact of the end of the Federal Reserve's ultra-easy monetary programs, according to Smith, and the diminishing returns of Japan and Europe's stimulus efforts.

"Those spigots have been open for so long that adding more monetary stimulus no longer moves the needle positively. Rather, the extreme measures push the global financial system into increasingly risky territory."

In Smith's view, U.S. investors have their heads in the sand when it comes to current global turmoil.

"One key element of the risk-on trade is the magical-thinking belief that the U.S. stock market is completely decoupled from geopolitical dynamics. In other words, Japan and Europe can sink into recession, China's growth can slow, the Mideast can be destabilized by multiple open conflicts and none of these issues will ever matter, as long as 'the Fed has our backs,' 'corporate profits keep rising,' etc."

Finally, from a technical standpoint, he noted that stock market volatility has been suppressed for so long by Wall Street's risk-on mentality, even while the S&P 500 has been pushing at lofty levels for years without a break, that a reversal is simply likely long overdue.

"Even the most avid bulls should grasp that market corrections of 10 percent to 20 percent are statistical features of all markets. Cranking markets full of financial cocaine so they never correct simply sets up the crash-and-burn destruction of the addict."

According to Investopedia, investors tend to engage in higher-risk investments when they perceive low risk in global economic patterns, and gravitate toward lower-risk investments when they perceive high global risks.

Last week, State Street Global Advisors launched an exchange-traded fund (ETF) designed to alternate between risk-on and risk-off strategies, depending on market conditions. The actively managed SPDR SSGA Risk Aware ETF has the objective of helping to "identify, quantify and benefit from risk factors moving the markets at any given time," State Street said.

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How can investors tell when they should do an about-face with their risk-on strategy in the stock market and move to a cautious risk-off strategy? Financial author Charles Hugh Smith counts up the ways on his Of Two Minds blog.
Charles Hugh Smith, risk, stock market, investors
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2014-17-15
Monday, 15 September 2014 02:17 PM
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