Market commentary is always slanted towards prices moving higher (leaving interest rates aside) on the understanding that up is good and down is bad. Makes sense, most people play it from the long not the short side. So last night’s price falls across a broad range of equities and commodities has investors and traders on the back foot today. Indeed the market commentaries in my inbox read “Caution Sweeps through markets”, “Shares drop as Japanese crisis weighs on sentiment.”, “Risk was taken off the table last night…” and the best one, and probably the most accurate was just simply “Sea of Red”.
But almost everywhere I’m reading that risk was off last night and we talk about “risk” here on Macrobusiness often too. But what does this term really mean?
The terms “risk on” or “risk off” have moved into common market parlance over the past few years to denote when the market is either bullish and going up or bearish and going down. The reason these terms have become so ubiquitous is that across many markets in price directional terms at least (for the statisticians amongst you I do not that this is not necessarily levels terms) markets have been moving pretty much in lock sync. For mine while I also use the term I usually follow it with an explanation that I think this is an oversimplification for what is really just a reflection of this directional correlation and the fact that short term “punters” dominate markets and that hourly, daily and weekly price moves are much more volatile than the underlying fundamentals justify.
Indeed I think for anyone interested in markets this shift towards short-termism is vitally important to how you interact with the market. For example a big European Fund Manager talking to a research buddy of mine summarised this best when he said “we all have 1 year views with 3 day stops”. That means they might investing with a return horizon of 1 year but they accept, and know, that market volatility may take them out in a very short space of time. That is a very weird way to run an investment strategy, medium term investors, should have stops aligned to their timeframe and return expectations not market volatility per se. It is a nod to the fact that in many markets are now driven by shorter and high frequency traders and indeed it adds to overall volatility when you get a market pullback.
I know some, probably many, people will disagree but as we creep up on the one year anniversary of the “Flash Crash” on May 6th last year I firmly believe that there remain lingering impacts on market psyche and the way investors invest. It’s looking more and more like trading than investing everyday. Last year I wrote another piece that quoted a speech given by Andrew Haldane, Executive Director, Financial Stability, Bank of England, titled “Patience in Finance” and said:
“But one of the key things we want readers to understand is that the trend to short termism of which the so-called “flash” traders are the most obvious recent iteration is an evolutionary manifestation of an intellectual version of Gresham’s law. That is impatience is chasing out patience as the holding period for investors and traders is shortened to such an extent that it becomes difficult, nay impossible, to hold a medium term view…
Haldane says:
In 1940, the mean duration of US equity holdings by investors was around 7 years. For the next 35 years up until the mid-1970s, this average holding period was little changed. But in the subsequent 35 years average holding periods have fallen secularly. By the time of the stock market crash in 1987, the average duration of US equity holdings had fallen to under 2 years. By the turn of the century, it had fallen below one year. By 2007, it was around 7 months. Impatience is mounting.”
And this is before flash traders and their super computers who knows how short the average holding period is now?
Short termism and impatience is no good for anyone, evolution has shown us that.
Which is all a long winded way of saying all that happened overnight was a bunch of traders using an excuse or two to take profit. The excuse, according to the FT this morning, was a Goldman Sachs note but it was an excuse nonetheless: The FT said the Goldies note:
advised clients in a note to lock-in profits on oil and other commodities because they looked vulnerable to a short-term correction. The bank’s recommendation seemed to hit a nerve in a sector that many saw as vulnerable after many months of strong gains and very high levels of “long” speculation.
We can see this in the chart below which shows the moves in the 5 key components of the Goldman Sachs Commodity Index:
This Goldies note along with the IMF’s WEO HH mentioned yesterday highlighted numerous times that the imbalances between surplus and deficit countries are out of control got some traders nervous and wishing to lock in profits. This was of course after the Japanese Nuclear escalation yesterday so it’s an environment where a little bit of money is being taken off the table given there was always going to be an inevitable bout of profit taking after the strong post Tsunami bounce . And that makes sense.
As I wrote on Saturday morning about the AUD and the likelihood of a short term pullback after the stellar run we’ve had. Indeed I wouldn’t be surprised on a purely technical basis to see it back at 1.0250 at some point as just a garden variety Fibonacci retracement. Its broken its uptrend, tried to break back up yesterday and is now losing upside momentum.
The same can be said for many other markets and this Aussie chart is similar to a lot of other ones where the bounce needs a pause. There are two types of pause generally. One is a sideways market and the other is a pullback. If the former takes hold then we might see some real “risk” off moves. But for now we’ve just seen a bunch of traders taking profit.
Disclosure: This post is not advice or a recommendation to buy or sell. Do your own research and consult an adviser before allocating capital.