Why 'Risk-on/ Risk-off' Is Here to Stay


Stocks continued their slide on this second post-election day. The Dow (INDEX: ^DJI) , and the broader S&P 500 (INDEX: ^GSPC) , lost 0.9% and 1.2%, respectively.

The macro view: This week, the CFA Institute polled professional investors with the following question: What do you expect to be the primary driver of equity-market returns during the next 12 months? Based on four possible answers, these are the results:

  • Economic news -- 32.5%

  • Corporate earnings -- 28.5%

  • Central bank policies -- 23.3%

  • Geopolitics -- 15.7%

Over the long term, equity returns are a function of three factors: dividends, earnings growth, and change in valuations, with the latter making the smallest contribution. Over the short term -- and 12 months qualifies as the short term for stocks -- the change in the price-to-earnings multiple that investors are willing to pay for stocks can easily overwhelm the other factors, which are relatively stable.

In the aftermath of the financial crisis, central bank policies and economic news (which are related) are arguably the key inputs that investors consider in determining the multiple they are willing to pay for stocks. If one is to believe the results of this poll, the risk-on/risk-off dynamic that has driven asset prices for the past several year will remain dominant for some time to come. If you want to sidestep it, and make your money on long-term return factors, you'll want to consider the 3 Dow Stocks Dividend Investors Need.

And, speaking of earnings, the third quarter earnings season is essentially over, with data for 414 companies in the S&P 500 in the books, representing 87% of index earnings-per-share. On that basis, it appears that quarterly earnings will experience a year-on-year decline for the first time in three years. That observation in itself is not troubling, as earnings have staged an extraordinary recovery off the bottom at the end of 2008; my concern lies instead with the $113.75 earnings estimate for 2013. Although that figure has been coming down -- it was almost $118 at the end of June -- it still represents a 13.3% increase over the 2012 estimate. That looks like a tall order in this environment.

The article Why 'Risk-on/ Risk-off' Is Here to Stay originally appeared on Fool.com.

Alex Dumortier, CFA has no positions in the stocks mentioned above; you can follow him @longrunreturns. The Motley Fool has no positions in the stocks mentioned above. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.

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