RISK MANAGEMENT ISN’T GOING OUT OF STYLE
It’s interesting how risk appetite’s have changed so dramatically in the last two years. Why is this interesting? Because, when you look under the hood at the Global economy you’ll notice that the problems that caused the car to veer off the road are all still in place. Nothing has really changed. We still have the same global imbalances that caused the crisis. The Chinese are still causing imbalances within their economy via a flawed currency peg. The single currency system with the Euro is still causing imbalances throughout much of Europe. And the financialization of the US economy is continuing along its merry way.
But, from an investor’s perspective there has been a distinct “risk on” trade in place. This is not surprising because asset prices are rising and the economy really is improving, however, you probably would have felt the same exact way in 2006 or in 1998 when everything appeared just fine. The truth was, risk management was probably more important at these two points in history than ever. John Hussman elaborated on this in his most recent letter:
“I recognize that investors are eager to move on to the thesis of sustained economic recovery, with no need for any risk management at all. However, it appears unwise for investors to rest their financial security on faith in a recovery that relies on the government running a deficit of 8.5% of GDP, simply to keep the existing 6.3% gap between actual and potential GDP from widening further. It appears equally unwise to rely on Fed purchases of Treasury bonds to sustain ever greater exposure of investors to risk, when the creation of financial bubbles does nothing to increase the underlying cash flows deliverable by the securities that are increasing in price.”
This sort of herd mentality might make the entire herd feel a bit more safe. The only problem is, the issues that caused this crisis to begin with are still stalking the herd. They’ll catch up with it sooner or later. It might happen in the next few weeks, months, years or even decade. No one can be sure exactly when, but they will catch up with it. And when they do the herd will disperse in panic and once again investors will have wished they’d been more aware of the potential risks at hand. Although fear and greed will continue to alternate dramatically during the investment pendulum swing, risk management is never going out of style.
all due to trend following, etf, HTF.
Profit presupposes the existence of trend;
All profit is trend.
Making sense makes no sense.
and to many traders, and machines, the whole market is just a couple of up and down lines.
The question is the direction, velocity, and acceleration of risk relative to potential return. None of these look good. This is a “risk off” environment on the long side, i.e., a bear cycle, as disinflation tending toward deflation shows. Generally speaking, for most people this is a time to save in assets that will appreciate due to the direction of the real interest rate rather than invest in expectation of inflationary winds. Good investment vehicles that will safely preserve capital are in short supply, hence generally already overpriced. Of course, this doesn’t mean that there are not trading opportunities both long and short. It just means that one has to recognize the trading environment, act accordingly, and be nimble.
TPC,
have you actually read Richard Fisher’s comments from November?
http://www.businessinsider.com/dalls-fed-chief-fisher-debt-monetization-2010-11
If you get past his take on “debt monetization”, he actually says MANY of the same things you say about this being a fiscal and not a monetary problem and thus why he disagrees with Bernanke’s QE. It’s a very interesting read.
Excerpt:
In sum, I asked that the FOMC consider that we might be prescribing the wrong medicine for the ailment from which our economy is suffering. Liquidity and abundant money are not the binding constraints on the economic activity we wish to see. The binding constraints are uncertainty about income and future aggregate demand, the disincentives fiscal and regulatory policy impose on ridding decisionmakers of that uncertainty, and the reluctance, given those disincentives, of those who have the power to create jobs for our people to invest in undertakings that would create them.
Read more: http://www.businessinsider.com/dalls-fed-chief-fisher-debt-monetization-2010-11#ixzz17MDlDtVe
Yes, Fisher is closer to “getting it” than most, but I still believe he has some fundamental flaws in his thinking.
Interesting, but stocks are risk free assets per the Fed’s willingness to backstop the world. As such, their risk premiums are far too high and by default, their prices far too low. Risk is an out-dated concept.
Dangerous thinking…..
Agreed. However, every day we see actions from and hear words from global central bankers that indicate they are unwilling to see asset price declines, whether those be in equities (US)or in bonds (Europe) or in everything (Japan).
Is the more dangerous thing not to take them at face value? As it stands, they seem to have been highly successful at keeping asset prices higher than they would be otherwise.
Nothing a handful of out of the money put options on the VIX can’t protect against is my logic, increasingly.