The Flight to Risk

During sharp market corrections one often hears about the so called “flight to safety”. This essentially means that investors are moving to cash and/or safer asset classes such as large/mega cap high dividend equities, US treasuries, etc. Since the beginning of the year a far different phenomenon has taken shape – There has been a pervasive flight to risk:

Using the Dow ($DIA) as a proxy for safety & quality among equities it is easy to see the outperformance by the riskier equity groups since the beginning of the year: Russell 2000 ($IWM), emerging markets ($EEM), and junior gold miners ($GDXJ).

Remember the TED spread which was supposedly such a good stress indicator that everyone was focused on a few months ago?

It seems that the $ECB’s LTRO and the promise of additional $FED easing has contributed to a steady narrowing of the TED spread since the outset of 2012. My friend David Schawel who is an expert in the fixed income space made an excellent point last night when he wrote:

“What is to stop positive 30yr real yields from evaporating?  Everything seems to scream that these positive real yields will go away. The earnings streams of institutions are being threatened here – how will they respond?  If the past few months are any indication, everyone is going to close their eyes and jump off of the “risk on” bridge – and probably hoping they are not alone. 

The implications are long term in nature; many institutions are funding these assets with short term floating rate liabilities.  This is all well and good if we stay at zero – however locking in fixed long term assets could be perilous in the future.  There are no easy answers out there, and any solution will result in risk whether it be interest rate risk, credit risk, and/or earnings repricing risk.”

Central bank monetary policy is forcing market participants to jump off the “risk on bridge” in a massive flight to risk. As one trader tweeted this morning “just buy and close your eyes” – this will surely end well……

The information in this blog post represents my own opinions and does not contain a recommendation for any particular security or investment. I or my affiliates may hold positions or other interests in securities mentioned in the Blog, please see my Disclaimer page for my full disclaimer.

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