Three key reasons behind the risk aversion

Asian markets are staring at a modestly weaker open, however one saving grace is that some of the falls in the US equity markets have already been priced in.

Source: Bloomberg

It must be said that price action in Australia yesterday was terrible. We specifically wanted to see if traders and investors would use the opening bounce in the market to offload stocks, and offload they did!

The moves in markets overnight have been caused by three things to me. Firstly, we have seen a further steepening of various yield curves, which in itself is not necessarily bearish if the cause is higher inflation and growth expectations. However, this is not the case, the move is being caused by the Bank of Japan looking to change the structure of its asset purchases, largely as a result of how poorly its asset purchase program has worked thus far. Throw in recent commentary (or should I say, lack thereof) from the European Central Bank (ECB) that throws into question the sustainability of the ECB’s asset purchase program, and you have a move higher in longer-term bonds, which no one is positioned for.

Secondly, some of the biggest systematic funds have had to alter their portfolios, many which have been at extreme levels. This has caused massive shifts in their portfolio and we have seen markets respond in kind. The rest of market participants have had to simply react, and when volatility increases, traders have to alter their strategy if they are to stay in the game. Pure and simple, if volatility increases and we see (price) range expansion, one has to look at altering position sizing, while pushing out stop losses to account for greater leverage in the market.

Thirdly, throw in comments from the International Energy Agency which have pushed crude price lower, and we have a further move out of equities. The concerning situation is the genuine reasoning behind the risk aversion move is very complicated for many to fully understand. The issues causing a strong correlation between equity and fixed income selling is not the same the European debt crisis. This is very different and one which many in the retail community seem quite unsure about.

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