Is Risk-On/Risk-Off Back?

After a solid day yesterday, stocks opened lower this morning, with the S&P 500 (SNPINDEX: ^GSPC  ) and the narrower, price-weighted Dow Jones Industrial Average (DJINDICES: ^DJI  ) down 0.17% and 0.24%, respectively, as of 10 a.m. EST.

The short view
On Jan. 25, when the S&P 500 had just finished capping a seven-day winning streak, I asked whether a secular bull market was underway. Since then, stocks have alternated between winning and losing days every day except for a single two-day losing streak last week -- and that back-and-forth looks set to continue today. Even as the correlation between individual stocks has declined markedly -- last Wednesday, the CBOE S&P 500 Implied Correlation Index with a January 2014 maturity hit its lowest value since its inception in November 2011 -- we appear to be witnessing a resurgence in our old friend "Ro-Ro" -- the risk-on/risk-off dynamic.

Of course, Ro-Ro -- or, more accurately, the risks that drive it -- never really left at all. As the Financial Times' Wolfgang Munchau wrote on Sunday:

A lot of people have become more optimistic about the eurozone, in some cases even euphoric. Hardly a day passes by without someone declaring the end of the crisis. But its two most dangerous aspects are unresolved -- zombie banks and macroeconomic adjustment.

Investors got a taste of that this week as a financial scandal engulfed the ruling party in Spain, roiling the Spanish stock market and pushing Spanish government bond yields to a six-week high. This was almost certainly a major contributing factor in Monday's U.S. stock market losses: The S&P 500's 1.2% decline was the largest since November.

Let's not forget that we have our own home-grown Ro-Ro drivers, too. For example, although it has not made the headlines in a couple of weeks, the fiscal cliff remains unresolved. These factors will be enough to produce periodic risk-on/risk-off spasms, even as markets normalize and stock pickers begin to reap the rewards -- this is par for the course.

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