Has The “Smart Money” Or The “Dumb Money” Been Reducing Risk?

Is it the “smart money” or the “dumb money” that has been seeking safer portfolio pastures throughout 2015? Time itself will tell. That said, riskier assets have been buckling clear across the asset board.

Consider the iShares 7-10 Year Treasury Bond ETF (IEF): iShares iBoxx High Yield Bond ETF (HYG) price ratio. A rising IEF:HYG price ratio signals an increasing desire for the perceived safety of U.S. treasuries over the higher yield-producing income of comparable corporates. The ratio has not been this high since mid-2014.

Another relationship that typically offers insight into investor risk preferences is the SPDR Select Sector Consumer Staples ETF (XLP):SPDR S&P 500 Trust (SPY) price ratio. When there is skittishness about the economy, cigarette makers, soda pop providers and toothpaste purveyors tend to outperform the broader large-cap market of U.S. stocks. As it stands, momentum for XLP relative to SPY is near 52-week highs.

Comfort seeking in treasury bonds over low-level investment grade bonds and higher-yielding junk bonds? A preference for recession-proof staples over the wider large-cap asset class? These are signs that momentum currently favors less risky alternatives.

Indeed, there are plenty of additional examples where the less risky asset is outperforming the riskier selection. Compare the perceived safer world of large-company stocks versus the perceived riskiness of owning small-company stocks via the iShares S&P 500 ETF (IVV):iShares Russell 2000 ETF (IWM). Like most price ratio comparisons today, the lower risk option is experiencing far greater demand than the higher risk option.

There are exceptions to the rule. For example, in foreign markets, large caps are underperforming small caps. This can be seen in the Vanguard FTSE All-World Ex US ETF (VEU):Vanguard FTSE All-World Small Cap Ex US (VSS) price ratio.

One possible reason for the trend toward the perceived riskier asset? Large foreign corporations are exceptionally dependent on international trade; lackluster world demand has put enormous pressure on exporters. In contrast, smaller companies around the globe are more dependent on their local economies as opposed to global trade. Another possible explanation? International small-caps have been beaten down so far that some may perceive them as more attractive from a valuation standpoint.