In A Ro-Ro Market: When the Going Gets Tough, Change the Rules

Ro-ro‘…short for risk on, risk off.

It’s just another acronym dreamed up by the market to describe the daily see-saw action in asset prices. Despite the complexity of the market and the millions of signals it throws off, we have managed to distil the daily price action down to either risk on or risk off.

Or perhaps it’s because of the complexity. It’s a complexity driven by constant government interference with the business cycle. We’re not sure exactly when it happened, but at some point over the past few decades governments decided that they could, and would, do everything in their power to avoid recession.

This resulted in lower and lower interest rates…because apparently all a downturn needs is lower interest rates to fire things back up again. But a lower rate of interest is just another term for the mis-pricing of credit. Holding the cost of credit below the market rate (the rate at which a free market would set the price) is a recipe for disaster.

It’s a policy that discourages savings and rewards consumption. Central banks make up for the lack of real savings by pumping reserves into the banking system, which pushes interest rates down. Then, when interest rates can go no lower, they start doing other stupid things like printing money outright.

All this does is creates a whole bunch of electronic money swirling around the system in a blind panic. The result is either risk on, or risk off.

Today, we are definitely risk off. And if you heeded the words of our resident technical analyst, Slipstream Trader editor Murray Dawes earlier this week, you wouldn’t be surprised at today’s market action. In Wednesday’s edition of the Markets and Money, on the eve of the Fed’s supposed new QE announcement, Murray wrote:

‘I have rarely seen a market so beautifully poised for disappointment. Pavlov’s dogs are salivating at the thought of more free money spewing out of the Fed tonight. If the Fed disappoints you are going to wake up to a US market down 2-3% tomorrow morning.’

Ok, so Murray was off by about 24 hours. Still, that’s some decent prognosticating. And he thinks this latest sell-off sets the market up for an even greater downside move in the coming weeks. To find out how Murray plans to trade this situation, keep your eye out for his special report, which should hit your inbox next week.

While traders love this sort of market action, it’s a real trying time for investors. Are there any left? We long for the time when the market was simply representative of the capital structure of the economy. When the equity market reflected the ‘equity’ value of all the listed companies and was sensitive to its various cycles. Or similarly, when the credit (debt) markets reflected the value of a company’s debt capital.

We suppose the markets still do this. But constant intervention and the advent of ‘ro-ro’ means you’re seeing increased synchronisation in all markets. There are few places left to hide…few natural hedges left.

Take gold for example. Throughout history it has fulfilled the role of being a natural hedge against financial upheaval. It still is, of course. But the creation of gold derivatives means there is more paper gold traded than there is physical gold in existence.

Therefore, the ‘paper’ gold market sets the price. And because of increasing market synchronisation, selling in one sector begets selling in another. What you think is insurance doesn’t act like insurance but actually still is insurance…confused? That’s not surprising. We’re drowning in a world of paper. As cracks appear in the façade, the solution is to create more paper…which creates more cracks.

Speaking of cracks, we just spotted a few more. This morning’s Financial Review reports:

‘China’s manufacturing sector has contracted for the eight consecutive month, according to a private sector survey, bringing concerns about the pace of slowdown in Australia’s largest trading partner back to the fore.’

‘…New export orders recorded their biggest monthly contraction since March 2009, during the global financial crisis.’

And here, we learn that China’s big four banks have only lent 25 billion yuan so far this month. This compares to a month long lending target of 1 trillion yuan. Given the big four account for nearly 40% of system wide lending, China’s banking sector has a bit of catching up to do.

But it will be ok; China’s leaders won’t let anything bad happen.

Crack number two? Moody’s downgraded the credit ratings of 15 banks last night. We’re not sure what to make of this. The ratings agencies are always behind the ball. They report on the past, not the future. But a downgrade does have ramifications. It increases the cost of debt capital for these banks. It also can impact collateral requirements, which has a whole host of implications.

But ratings agencies can only have so much of an impact. If they get too zealous, TPTB (The Powers That Be) change the rules of the game.

According to the Financial Times:

‘The European Central Bank is expected to give Spanish banks a much-needed boost with a significant loosening of rules on collateral required to obtain its liquidity, which could be followed by steps to reduce the role of credit-rating agencies in its operations.

‘The concession, which could be announced as early as Friday, would allow Spanish banks to make greater use of asset-backed securities when drawing ECB funds. The move – coming as European authorities and Madrid draw up plans to recapitalise the country’s banks – will help to offset a possible liquidity squeeze caused by downgrades by credit rating agencies.

‘The decision by the ECB’s 22-strong governing council is part of a review of collateral rules aimed at ensuring liquidity continues to flow to sound eurozone banks – and to reduce its reliance on external bodies such as Standard & Poor’s and Moody’s.

In case you were dozing off, we underlined the important bits.

Seriously, can you believe it? We’ve now got to the point where the authorities want to ignore the credit ratings agencies because it doesn’t suit them anymore. This is a turnaround from the pre-credit crisis days where the agencies ignored the growing problems and bankrupt balance sheets of the banks. Now that they decide to get serious no one wants to listen to them.

You couldn’t make this stuff up. It’s hilarious in its absurdity. The rules of capital allocation, of risk and reward, no longer count. It’s little wonder the world is caught in a cycle of ‘ro-ro’. Outcomes are now binary. There is no place for nuance. You’re either in or you’re out.

But in a worrying sign for Europe, the authorities look increasingly like they are going ‘all in’. Europe is descending into farce. Watch and weep.


Greg Canavan
for Markets and Money

Greg Canavan
Greg Canavan is a contributing Editor of Markets and Money and is the foremost authority for retail investors on value investing in Australia. He is a former head of Australasian Research for an Australian asset-management group and has been a regular guest on CNBC, Sky Business’s The Perrett Report and Lateline Business. Greg is also the editor of Crisis & Opportunity, an investment publication designed to help investors profit from companies and stocks that are undervalued on the market. To follow Greg's financial world view more closely you can subscribe to Markets and Money for free here. If you’re already a Markets and Money subscriber, then we recommend you also join him on Google+. It's where he shares investment research, commentary and ideas that he can't always fit into his regular Markets and Money emails. For more on Greg go here.

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Increased synchronisation? I suggest you have another look.


A Ro-Ro has long been the handle given to a roll on – roll off ship. They work fine unless operators fail to secure or maintain the door; the consequence of which is dire indeed.

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