SP:SPX   S&P 500 Index
The Paradoxical Risk-on/ Risk-off Asset positive correlation:

1. Risk off assets have outperformed to date, with Gold             leading the gains at 28%, JPY following at 18% and US 10y treasuries Trading 16% up in 2016 - average at 20.5%.

2. Meanwhile, SPX             trades 5% up since 4.1.2016 but more importantly, since 20th January lows SPX             is up 15%.

3. this is significantly paradoxical, as fundamentally, Risk-on assets shouldnt trade well when safe havens do and the reverse can be said about Risk-off bull markets - Equities shouldn't trade higher.

- the reason this positive correlation of both risk and safe haven assets rallying at the same is problematic is that in the long-run it is not sustainable - one MUST adjust to the downside as markets in the short-run trade as a zero sum game, liquidity is inelastic and non-infinite i.e. they cannot both keep gaining capital as there is a limit when all available liquidity is allocated. Consequently, at this point investors then have to forgo investing in one asset, if they want to speculate on another, as they dont have any new cash to invest - this is why we normally see safe havens and risk assets trade negatively correlated and price action is "seesaw" like most of the time as investors take money out of risk, for example, so they can allocate it to risk-off, as perceptions and market environment changes.

Cause of the paradox:

1. An Unusual even split in investor risk sentiment e.g. in the immediate term, some believe the environment is stable enough to offer risk higher ( CB             easing/ support driven views), whilst others believe global risks are heightened enough to offer safe havens higher (Brexit, US election, China). Hence we see both SPX             and Risk-off grow. Normally, the markets trade like herds e.g. behaviours skew to risk on or off, grouping with a strong bias to one side at the same time. This more "evenly distributed" sentiment we are experiencing rarely materialises as usually there is consensus on market risk e.g. all investors rationally agree that "now" is a highly uncertain time or the other way, given the same information is available.

2. Most likely imo, however, is that there is a short-term imbalance/ artificial risk inflation , where risk assets yet again are buoyed by central bank impetus. Following the brexit result a cascade of global CB             dovishness/ support was injected into the markets providing the perfect artificial rise in equities - whilst the underlying market sentiment continues to follow the 2016 risk-off trend (as is shown by the 2016 outperformance of off (+21%) vs on (+5%), CBs             have provided sufficient support to mask the risk-off bias - however it is unlikely to continue for long.
Comment: Trade the paradox:

1. in general i believe we are due a structural 10-15% repricing of equities lower to account for the impending increased interest rate and tighter QE environment - as fundamentally CBs become relatively illiquid with possible further easing policies e.g. All central banks are finished with the bulk of their APPs and are nearing their terminal purchase amounts + most central banks have stretched rates 80% as far as they are likely to fall - thus the bulk of the "easy money gains" stocks have enjoyed since 2008 are coming to an end, likely at the end of next year. This sooner rather than later will be priced into stock downside as participants aim to get a run on the market. Brexit may have seemed to have flattened this expectation, and pushed it into the future. However, apart from the BOE, i dont believe brexit will materially impact other CB policy e.g. BOJ/ ECB/ RBA/ RBNZ needed to ease further anyway, so apart from delaying perhaps the Fed hike, what impact will it realistically have? Long run = 0, immediate term = supportive rhetoric 6-10% rally (as we are seeing now - but it wont last long).

- The best way to play an inelastic or "shorting" CB policy is undoubtedly to sell equities (particularly financials). We can see already by looking at financials performance recently both stock and income statement, that the QE culture is coming to an end as bank revenues and profits plummet (as the Billions of CB Credit flows + heightened FX transactions come to an end).

*See Part 2 "RISK ON/ OFF PARADOX CORRECTION - SHORT SPX/ FTSE & USDJPY P2 " for implementable recommendations to trade this view
Good analysis. Nicely done.
Brilliant. I agree with the equity correction downwards - SPX is close to its all time high but the days of cheap borrowing are coming to an end...
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