By Andrew Harmstone
Investors continue to demonstrate a willingness to take on risk. Recent lows in risk indicators such as the VIX and the iTRAXX Crossover index continue to suggest investor risk aversion is falling. Moreover, global equities have risen sharply since the end of 2012, consistent with a rising risk appetite. Recent currency moves, a rise in the value of the euro – as confidence in the eurozone improves – and a fall in the yen, often thought of as a ‘safe haven’, may confirm a greater willingness by investors to take on risk.
Paradoxically, the ‘risk-on’ attitude of investors, by facilitating appreciation in the euro, might have detrimentally affected the economic prospects for the eurozone by making its exports less competitive. This in turn could help explain why eurozone stocks stalled and fell back in early February.
Other factors undoubtedly also have led investors to re-evaluate the attractiveness of eurozone equities. This includes the upcoming Italian election. Italian polls are showing the ‘anti-establishment’ (and euro-sceptic) Five Star movement may now be the third most popular party in Italy. Moreover, the centre-right coalition of ex-Prime Minister Silvio Berlusconi is making strong gains in the polls on populist promises that could undermine Italy’s austerity measures, which are crucial for international bond holders to maintain confidence in Italian debt.
The dramatic fall in the value of the yen may also be partly a consequence of a renewed investor appetite for risk. The yen, in contrast to the euro has generally been viewed as a ‘safe currency’ – that is one that tended to rise when global risk levels rose. A ‘risk-on’ environment would favour a decline in the value of the yen.
It is true that the policy of the new government of Prime Minister Shinzo Abe has been to re-start the Japanese economy and fight deflation by, among other things, aiming to lower the value of the yen. Moreover, since 14th November when the Japanese election was announced and it became clear that Abe was likely to win, the yen has fallen over 14% relative to the U.S. dollar. Nonetheless, it is unlikely Abe’s policy initiative to weaken the yen would have been so strikingly successful if investors were still looking to park funds in the yen as a safe haven.
In summary, investors appear to continue to have an appetite for risk. In view of this the outlook for ‘risky assets’ such as equities may continue to be good generally. The benefit of this ‘risk-on’ environment is unlikely to be felt evenly by each regional equity market, however. For example, one consequence of this environment may have been a sharp rise in the value of the euro. This rise in the euro may paradoxically in turn have dampened badly needed external demand for eurozone exports. This could have a detrimental impact on eurozone equity markets relative to others. In contrast, a ‘riskon’ environment may have facilitated the decline in the value of the yen, which in turn is likely to benefit Japanese equity markets relative to global equities generally.
Andrew Harmstone is managing director, Morgan Stanley Investment Management
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