Investors don’t always prize returns above all else. Consider the 2008-09 global financial crisis:
Stocks, commodities and most other assets linked to global economic growth floundered in tandem as much of the world sank into recession. An investor faced with such an environment will reasonably look to pull money out of those assets that are falling and transfer them someplace safe to wait out the carnage (such an investor is said to be to be “risk-averse”, meaning he/she doesn’t have a lot of tolerance for risking their capital to achieve a return).
What is “safe”?
First, this would need to be an asset that is abundantly liquid. That means its supply is sufficiently ample to absorb a lot of new demand pouring out of other markets without altering the price too much in the process. Otherwise, moving money into and out of this supposedly “safe” asset can create a lot of volatility, which translates into a greater risk of loss.
Second, this asset should be a good store of value, meaning investors’ capital will not be rapidly eroded while they wait for market conditions to improve. Historically, a prominent example of this in the foreign exchange market is the Japanese yen. It is very liquid, and perennially low inflation has meant that the currency’s purchasing power has held up well. Needless to say, that makes it a good store of value as well. Notice that “returns” are nowhere to be seen in this equation because the focus here is to keep what you have, not grow it.
This dynamic has been on full display in recent days. The yen has moved broadly higher against its major counterparts as the S&P 500 – a benchmark for market-wide risk appetite – turned sharply lower. The US equity benchmark represents the collective earnings outlook for the world’s largest public companies. Broadly speaking, these earnings are a function of the trend in global economic activity. When traders become leery about growth prospects, earnings expectations decline and trigger risk aversion, putting downward pressure on share prices.
