Roxi_117 wrote a note · Apr 20, 2024 13:42

(Under verification) Risk ON/OFF judgment model

Due to lack of experience, I have struggled to make risk-off judgments and decisions, repeating buying and cutting losses in April. I have summarized my reflections on this topic below:

[Model]

Conditions for appearance of a downward trend in stock prices (example)

[1] Rapid increase in interest rates (red triangle in the diagram above)

[2] Exceeding the limit of interest rates (red square in the diagram above)

[3] Recession (rapid decrease in interest rates)

Deflation (ultra-low interest rates)

Others (natural disasters, geopolitical risks, legal and regulatory changes, changes in the assumptions of leading markets, etc)

If none of the above apply, it is expected that the market sentiment will be biased towards inflation, and even with a gradual increase in interest rates, there is a rough macro upward trend in stock prices, as can be seen from past data.

Regarding the situation currently facing [2], there was a suggestion that the decision on risk ON/OFF can be made by using the interest rate of the US 2-year Treasury bonds (approximately 4.7-4.8 under the current conditions) as a reference.

Reference: Youtube by Ryo Okazaki, April 19, 2024 https://youtu.be/cM4vGZO5nbA?si=w3xQkGp_C9_sXAYk

The reason for the rise in market interest rates may be due to customers withdrawing funds from banks because the interest rate on securities market MMFs is higher than on deposits, or because banks are selling government bonds to prepare for relaxed commercial real estate demand and set aside loan loss provisions and FDIC insurance premiums. It could also be due to banks selling government bonds for cash raising as BTFP ended in March, or due to the continued selling of US government bonds as the FF interest rate cut is becoming less likely, or perhaps due to the visible areas of emerging market dollar debt default, etc., where a breakdown in fund circulation may occur, causing a recession to have already begun, requiring further comprehensive information gathering, analysis, and consideration.

Reference: Youtube by Money Health Channel, April 14, 2024 https://youtu.be/9EZOKQI21e0?si=l5pgSJojhQHTLG56

This model is simply a macro indicator. It is not known whether it will be valid forever. There may be many exceptions depending on individual stocks or industries, and there may be fluctuations in stock prices due to other reasons.

Around the 2008/09 Lehman Shock, even when the U.S. 2-year bond yields entered the territory of excessive increase, stock prices continued to rise. However, after the breakdown of the real estate market cycle leading to recession, stock prices plummeted further, and a rapid cut in the federal funds rate was implemented. It is not strictly observed that stock prices fell beyond the judgment value (yellow line) mentioned above [2], but it is possible to move towards risk-off when entering the mentioned [3].

Due to the risk-off decisions made by many individuals based on the direct confrontation between Israel and Iran on 4/19, the Nikkei stock prices plummeted. At that moment, not only were Japanese government bonds and U.S. government bonds purchased, leading to a strong yen, but also the dollar index simultaneously rose, resulting in a rare phenomenon known as 'strong dollar and strong yen.' However, when things calmed down, U.S. government bonds were sold again, U.S. government bond yields rose again, and the trend shifted back to a strong dollar and weak yen. The following morning, it was confirmed that U.S. stocks also showed a corresponding downward trend as suggested by this model. Fundamentals insights such as current strong performance and weak guidance were also included, along with a wide range of possibilities.

Reference from Youtube by Emin Yulmaz on 4/19/2024.https://youtu.be/7o3danmGMMo?si=Eo8XaXi8N8o7es6k

Even if the federal funds rate is kept constant, if control over U.S. government bond prices is not maintained, additional interest rate hikes may occur in the market, potentially leading to a scenario similar to the situation mentioned in [1] where stock prices decline further. If this intensifies, it may be advisable to shift from a bull-long strategy to a risk-off bear-short strategy and switch back to risk-on.

The truth about the future will not be known until it becomes the present. As this model has not yet become a consensus, readers are encouraged to conduct various verifications and make judgments and decisions at their own risk.

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Roxi_117

2024/02 入門

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