Risk levels continued their downward trend through the fourth quarter into 2013 with no sign of reversal, according to data from Axioma Inc.
But while “this hangover from the financial crisis seems to be dissipating,” it hasn't stopped people from worrying about how long the good news can last, noted Melissa Brown, New York-based senior director of applied research and co-author of the Axioma Insight Quarterly Risk Review.
“One question we get a lot is, is there is only one way to go? That's not necessarily the case,” said Ms. Brown. “You always need to be careful, but you don't need to sleep with one eye open. We can reference instances where risk has held steady at current levels for periods lasting years.”
Still, with risk much closer to all-time lows than historical peaks, “it means that it is probably not going to get dramatically lower,” she said.
But for any investor worried about putting money into the (stock) market, the continued drop in risk after the fourth quarter of 2012 “in and of itself is good news,” she said.
Another positive sign at the end of 2012 was exceedingly low asset-to-asset correlations. “That's good news for stock pickers because if correlations are good, there should be a good payoff for being able to pick the right stocks,” Ms. Brown said. Instead of worrying about common themes affecting all stocks, “it's an opportunity for active managers,” she said.
Ms. Brown said that low risk going into 2013 also helps ease the pressure on returns. “To the extent that risk is lower, you actually don't need to have as high a return to justify the risk as you did a year ago or two years ago.”
Risk continued to drop by the end of 2012 even for what Axioma calls the “eurocrisis countries” of Greece, Spain, Italy, Portugal and Ireland, where risk over a medium horizon of three to six months fell by nine percentage points, in sharp contrast to their risk levels six months ago. By the fourth quarter of 2012, “you were seeing a lot less volatility,” said Ms. Brown. “This goes along with this idea that we don't have one theme driving all stocks.”
Medium-horizon risk for the Russell 1000 and Russell 2000 also dropped in the fourth quarter, although less dramatically. Forecast risk for large-cap U.S. stocks was on par with that of the FTSE Emerging index. That is an abrupt departure from the fourth quarter of 2011, when the Russell 1000 was well below the FTSE Emerging index. Short- and medium-horizon forecasts also fell substantially for the FTSE Asia-Pacific ex-Japan.
This article originally appeared in the February 18, 2013 print issue as, "Years of pain have investors questioning good news".