Risk Off & Risk On

NERD ALERT: This edition of TGIF 2 Minutes will get a big “wonky” but still worth the read. A good number of people reading are familiar with the terms, “risk off” and “risk on,” terms that are used frequently in financial media and by financial industry traders and risk managers.

Even for a business owner or anyone familiar with risk, the term “risk on” or “risk off” may make sense. But for those still wanting clarification on how these terms relate to personal savings and investments – specifically the stock and bond markets – here are a few details.

First, the reason it made sense to highlight this topic is that just this week the US Fed said,“[The US] economy has made progress toward its goals, teeing up bond taper.” *

Think of “risk ON” as increasing risk and being comfortable with taking on more risk; whereas “risk OFF” would be decreasing risk due to factors that make risk uncomfortable.

This sentence is loaded with more questions than answers. In that vein, US bond markets and various US stock indexes reacted differently to this news. Think of “risk ON” as increasing risk and being comfortable with taking on more risk; whereas “risk OFF” would be decreasing risk due to factors that make risk uncomfortable. After the Fed’s statement this week:

  • Small company stocks shot up over 1% (example of “risk ON”)
  • Large-company, high profile stocks in the Dow Jones went down 0.30% (example of “risk OFF”)
  • Tech stocks barely edged up (neutral toward risk)
  • Bond yields, ironically, stayed low or nearly the same (somewhat example of “risk OFF”).

Note, bond yields decrease when bond prices increase as investors fly to safety and buy low-risk government bonds.

In general, an increase in small company stocks indicates investors’ belief in the overall strength of the economy. Think: small businesses able to start up, investors’ confidence in the risk of borrowing money – money able to be paid back on schedule due to strong levels of consumer and business spending. This state of affairs could be called “risk ON”.

Normally (whatever “normal” is these days) in a risk-ON environment, bond yields may increase meaning that investors sell bonds and are happier to own stocks. But in these somewhat unusual and abnormal times, in a risk-ON environment for stocks, bonds are also being purchased (risk-OFF).

A keen observer may quickly figure out that the conditions of risk-on and risk-off change constantly and without warning to the stock and bond markets. With current record amounts of real and proposed government spending and debt plus massive amounts of stimulus money still flowing, decisions regarding risk-on and risk-off can change multiple times intra-day.

If you have managed to read this far, realize that these “wonky” factors are what your financial adviser is monitoring – so you do not need to in terms of investing.

Overall, the current risk-ON sentiment in stocks seems to be fairly widespread. Gross Domestic Product (GDP) which is the broadest measure of US goods and services produced is currently strong but with certain caution about the intermediate-to-long-term durability of the US economic rebound. Investors are wise to establish a predetermined asset allocation regardless of what the financial media deems “risk on” or “risk off” to avoid being caught in the whiplash of the financial markets. Now time to have a great weekend!

*WSJ.com, Nick Timiraos, July 28, 2021.

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