Thinking about where various assets lie in the sliding risk scale can help investors identify alpha as cycles rotate over a time horizon.
Stocks and bonds are not only different asset classes. They also rank on the opposite end of the sliding risk scale.
Safe haven assets, bonds, and precious metals lie at the lowest end of the sliding risk scale.
“Stocks and bonds are not only different asset classes. They also rank on the opposite end of the sliding risk scale”
WEALTH TRAINING COMPANY
The same asset class also ranks differently on the sliding risk scale
So taking sovereign debt, prime collateral US treasuries lie on the lowest end of the sliding risk scale compared with Argentine sovereign bonds, where the government has defaulted twice in twenty years.
The more risky bonds offer higher yields to compensate for default and capital destruction.
Not all stocks are the same as there are high beta low beta stocks that rank differently on the sliding risk scale
High beta stocks positively correlated to the index, but they also amplify the magnitude of movements.
So high beta stocks, high on the sliding risk scale, will outperform in a bull market. But they can massively underperform in bear markets.
“Not all stocks are the same as there are high beta low beta stocks that rank differently on the sliding risk scale”
WEALTH TRAINING COMPANY
So the Ark Fund‘s massive underperformance, down 61% over the year, as the stock market went into bear territory as central banks ditched the transitory inflation narrative and aggressively tightened to fight entrenched inflation.
Moreover, what made the losses worse was that the fund managers doubled down on the losses by averaging down, which led to compound losses.
“High Beta stocks, The Nasdaq technology-laden index, cryptocurrencies, the millennials’ version of technology stocks, beta stocks, and junk bonds are an example of high-risk assets” – Wealth Training Company
Identifying where stocks rank on a sliding risk scale and understanding the impact of cycles on assets along the risk scale could aid profitable portfolios
When the investment psychology cycle is in a thrill, and the central bank liquidity cycle is peaking, risky assets have reached a price resistance level.
So in this scenario, with an investor in a thrill, central bank liquidity at maximum, assets on the high end of the risk will amplify any pending price correction.
But the riskiest of assets will provide alpha when bought at the bottom price when the investor psychology cycle is depressed, when the economy is in a recession, and most importantly when the central bank liquidity cycle has troughed and heading higher.
What are high-risk assets on a sliding risk scale?
High Beta stocks, The Nasdaq technology-laden index, cryptocurrencies, the millennials’ version of technology stocks, beta stocks, and junk bonds are an example of high-risk assets.
So when the cycles turn bullish, the riskiest assets will outperform.
Capital flows into beaten-down risky assets, which drives prices higher. Then momentum builds as the investment psychology cycle shifts from depression, to belief in the rally, optimism, and thrill.
So the takeaway of this piece is to understand where assets lie in the sliding risk scale and that cycles influence the performance of asset prices. Moreover, capital flows to the best rate of return, and when sentiment shifts to risk that means the riskiest assets will outperform safe-haven assets.
