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Keeping on top of the RORO markets
Fiona Clark, February 2013
RORO stands for Risk-On, Risk-Off, and it’s a short hand way of explaining what has happened to markets – specifically, that short-term market sentiment is having more influence than usual.
On a Risk-On day, people are happy to embrace a bit of risk in their portfolios. At a macro level, this might mean investing in Australia and buying shares and commodities and the US dollar. At a sectoral level, it means buying materials and energy stocks, some cyclical consumer stocks and getting out of “defensive” sectors. The basis is that the growth outlook is rosy and the future is bright.
On a Risk-Off day, the reverse happens. Investors are supposedly nervous and sell their shares (particularly in risky countries like Australia), buy bonds and gold and move all their equity holdings to the “defensive” stocks like health care, utilities and staples. The risk-off sentiment is that the world is in bad shape.
It seems strange that investors find it so difficult to make up their minds about whether they are nervous or confident about the future, but the RORO cycle has become self-perpetuating. A piece of positive data from China and WOW! It’s Risk-On for a week (or even just a day). Everyone executes the trades because they expect the moves will be made and they’re trying to get in before markets rise.
The last 12 months have been dominated by RORO trends and it’s fair to say that we’re currently in an extended Risk-On phase. But before we all get too excited, this type of activity is reasonably common when trends are reversing or uncertain – i.e. inflexion points. For example, will China have a hard landing or has it turned the corner? As each piece of data is released the future (hopefully) becomes more certain. If the change in trend is finalised and we are on an up (or down) trend, then RORO type activity becomes less significant; a bad economic number becomes merely an anomaly or signals specific sectoral weakness.
Eventually short-term sentiment will become less influential. Focus should return to more fundamental based analysis. Earnings, company management, balance sheet strength. Basic stock picking skills will become more significant than screen watching.
We’re not quite there yet, but I sense that the strength in the market over the last few months means that investors are becoming more comfortable with the global growth outlook and that the ROROs will eventually peter out.