This caused us to go over the totality of our indicators to see if there was something new. It has led me to slightly revise my view on the world. Ignoring some of the fine print, my new contention is that the risk-on rally is over. Instead we have entered a more normal phase where rotation between asset classes will be the normal driver of dynamics. There will again be room for stock picks, value investing, ratings arbitrage, automatic trading algorithms and what not.
We have come to understand the risk-on/risk-off as something that applies in extraordinary situations. Those situations are when the correlation between asset classes increases enough to make diversification irrelevant. All of our risk indicators have dropped sharply and have now begun to stabilise at “normal” levels. It means that risk-on/risk-off slides into the background.
The financial markets react to changes, relative and absolute. Now that the risk situation has nearly normalised, it is only normal that market attention moves on to something else. The market, after all, is the ultimate ADHD child.
Will risk-on/risk-off trades come back into fashion? Probably. There are enough things out there that have just been plastered over. But it is impossible to predict, so we just reserve the right to react when it happens.
Quite a spat is building between Bundesbank and ECB. Bundesbank chief Weidmann is intensely critical of ECB’s policy of covering everything and everybody in cheap liquidity. In particular, Weidmann is worried that the cheap liquidity could create a situation where “banks are discouraged from taking action to restructure their balance sheets and strengthen their capital base”.
Since Weidmann can safely be assumed not to be a complete idiot, this statement shows in all its horrifying clarity how much Bundesbank ideology is isolating the institution from seeing what is going on in the real world.
ECB is trying to counter the strongly negative effects on economic growth coming from thedisastros demands that the banks strengthen their capital base right at the point where German-driven budget cuts bite the hardest. With such friends in Bundesbank, the European economy will certainly not need enemies anytime soon.