1. Risk-On Risk-Off: Its effect on the Australian stock market TARIQ HAQUE

2. What is Risk-On Risk-Off? Risk-On: When many investors are less risk-averse and buy risky assets such as equities and sell off safe assets such as bonds Risk-Off: When many investors are more risk-averse and sell risky assets such as equities and buy safe assets such as bonds A global and recent phenomenon – Events that have caused Risk-Off: Ben Bernanke warning on US subprime crisis (July 2007) Collapse of Lehman Brothers (September 2008) Downgrading of US Sovereign debt (August 2011) Ben Bernanke announcing a wind-down of QE (June 2013) – Events that have caused Risk-On: Ben Bernanke announcing QE 1, 2,and 3 Draghi Put speech (July 2012) University of Adelaide2

3. Implications of Risk-On Risk-Off Intra-stock and intra-bond correlations more positively correlated – Correlations between stocks and bonds become more negatively correlated Greater volatility in returns to an asset class Greater importance of sector allocation within an asset class compared to security selection Importance of Factor timing Effect on carry trades and Long/short strategies University of Adelaide3

4. Focus of this study What effect does Risk-On Risk-Off have on the Australian stock market? How do we classify a Risk-Off or Risk-On market? This is an important question as RORO often coincides with financial crises and there is a lot of capital invested in equities (due to super) University of Adelaide4

5. Data Sample period: April 2002 – April 2013 Weekly returns to 10-year government bonds: US, UK. Japan, Australian, European Monetary Union Weekly returns to equity indices: S&P 500, Russell200, FTSE 100, Nikkei 225, Eurostoxx 50, Dax 30, ASX200 Rolling correlation technique using a rolling window of 52 weeks University of Adelaide5

6. Changes in correlation over time University of Adelaide6

7. Risk-On Risk-Off in our sample University of Adelaide7

8. Average returns(%pa) in RORO vs Non-RORO periods University of Adelaide8 Non- RORO RORORisk-OnRisk-Off ASX200 14.8% 0.5%86.9%-89.8% ASX_GOV_BOND 5.7% 7.3%-7.5%22.8% GROWTH14.3%2.3%92.9%-92.3% VALUE15.8%2.1%86.6%-86.3% LARGE_GROWTH13.8%2.4%91.1%-90.3% LARGE_VALUE15.5%2.1%86.3%-86% SMALL_GROWTH17.8%2.6%105.5%-105% SMALL_VALUE17.2%0.0%88.6%-92.7% ASX10017.5%0.9%86%-88.1% ASX_SMALL_ORDS12.6%-2.8%99.7%-109.8%

9. Average returns(%pa) in RORO vs Non-RORO periods University of Adelaide9 Non- RORO RORORisk-OnRisk-Off CONS_DISCRETION6.5%-1.7%67.1%-73.7% CONS_STAPLES17.1%5.7%46.4%-36.9% ENERGY27.7%-4%100.8%-113.4% FINANCIALS14.5%2.4%89.5%-88.6% HEALTHCARE17.9%4.4%38.6%-31.3% INDUSTRIALS11.5%-5.2%77%-91% IT15.5%0.6%67.5%-69.4% MATERIALS19.4%0.9%126.5%-130.3% T’COM_SERVICES8.5%8%31.9%-16.9% UTILITIES18%4.7%46.2%-38.5%

10. Conclusions The performance of the Australian stock market is vastly different in normal conditions versus Risk-On Risk-Off conditions Risk-On Risk-Off conditions have been in existence from July 2007 – December 2012 Other important applications: – Foreign exchange, commodities, bonds, property – Asset allocation in superannuation funds – Forecasting Risk-On Risk-Off Will Risk-On Risk-Off continue into the future? University of Adelaide10