Disappearing of Risk on/Risk off and Volatility

Is Risk-On, Risk-Off in the Rearview Mirror?

One thing that may matter most for your portfolio in 2017—and how you manage risk—is how markets responded to surprises like trump, Brexit in 2016.


In each case, global stock markets and other risk assets initially sold off, only to recover swiftly -> As any investor active in recent years knows, risk-on/risk-off has been a recurring pattern in markets since the global financial crisis. -> keeping pace with abrupt shifts in risk sentiment (market timing) has been a challenge

The risk-off periods certainly appear to be getting shorter -> If this risk-on/risk-off pattern is breaking down (to be replaced by trending markets)?

Explanations: global growth is finally starting to gain traction boosting many growth-sensitive risk assets, such as stocks and high-yield bonds <-developed markets are moving beyond a singular reliance on monetary policy to boost growth (Japan is supplementing ultra-loose monetary policy with fiscal stimulus, and the US may soon do the same

Implications: Momentum and volatility, for example, may become important factors driving stock markets again. (less important when risk-on/risk-off prevailed)

atkin_riskonriskoff_display-2_d1actual stock market volatility is unusually low today. But that doesn’t necessarily mean we’re in for a long, tranquil period. Other measures, such as the spread between implied and actual volatility, tell a different story.

->> If we’re entering a period of reflation—or renewed inflation—and moderately faster growth, investors will want the ability to move seamlessly across asset classes and regions into areas best positioned to benefit from higher prices. These might include commodities, currencies or select emerging markets. -> A holistic, multi-asset strategy allows investors to pivot quickly to seize these types of opportunities

->> If markets are entering a new period in which assets trade based on their own merits rather than on what central banks do, a hands-on approach will be essential.

->>> investors may be tempted to put their portfolios on autopilot, thinking they can stay afloat just by going with longer-lived trends <- a risky approach as even in trending markets, there’s always the possibility of an expected disappointment or a big sell-off.

Surprises/uncertainty that might upend the current growth trajectory or policy outlook:
Will Britain negotiate a smooth exit from the European Union?
Which policies will Trump prioritize—and which will he get through Congress?
Will French and German voters opt for antiestablishment leaders of their own in elections this year?


2016 Was Not a Particularly Volatile Year

Though sounds like, financial markets in 2016 wasn’t a crazy year. In fact, it was amazingly normal.

<- Annualized daily volatility during 2016 came in at 13.1%. Based on rolling same-length periods going back to 1929 this falls at the 47th percentile, as well as at the 54th percentile since WWII, the 42nd percentile since 1990 and only at the 54th percentile when compared to the last five years.
-> Realized daily volatility simply was not high in 2016 compared to pretty much any prior period

1-Year Daily Rolling Volatility (1946-2016) / Time Series Plot010317_1yovol010317_1yovoltimeseriesSource: AQR and Bloomberg using the S&P 500 index.

Max 1-Month Absolute Return Over Prior Rolling Year (1946-2016)010317_1moabs
Prior 1-Year High Divided By Prior 1-Year Low (1946-2016)010317_prioryrhilo

2016 Beyond Equities: Still Boring

In 2016, not only equities was plain, boring, and average. Cliff’s analysis was further extended to include a broader set of markets: fixed income (Barclays Aggregate U.S. Index “Barclays Agg”); commodities (GSCI Index “GSCI”); currencies (Dollar Index “DXY”); and volatility itself (VIX Index “VIX”). Similar to what we observed in equities, when looking across realized risk/variability metrics, 2016 was pretty ordinary across the broad set of markets.

Historical Percentiles of Risk Measures by Asset Classes since 1990011017_exhibit1

Commodities were the only one one asset class that showed above normal risk/variability in 2016. / the dollar was calmer than normal on all measures, and the VIX was just about at the median

Historical Percentiles of Risk Measures by Asset Class since 2012 (a Normal year)011017_exhibit2

The Becalming of Stock Volatility

Markets have been eerily calm for the past few months.


Despite lots of evidence the peace is related to improving economic expectations, the tranquility continues to strike some people as weird. One thing they cite is a measure of global policy uncertainty that has gotten more extended versus the fear gauge than at any point in the past two decades.

“We have a new president who’s completely unorthodox, yet the market’s not moving,”  “It’s a challenging time for investors because they see all these risks, but the market is waving them off.”
Mostly worried about: unwelcome political developments and unexpected Chinese currency debasement.


Volatility and performance in stocks can be very cyclical over time, and in a different way.
These things don’t run on a set schedule, but it makes sense for investors to understand how markets typically function over the long haul.)



-> This shows how the cycle of fear and greed can play tricks on investors over time. When markets become too calm, investors can become complacent. / And when markets become too volatile, it can put investors on edge far too often. ->>  Highly volatile, low-returning markets end in fear, which leads to higher-returning markets with much lower volatility, followed by the eventual greed that starts the cycle again.




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