The Real Reason Investors Aren’t Afraid of Risk These Days

Investors RiskThe Chicago Board Options Exchange (CBOE) Market Volatility Index—better known as the “VIX” or even the “fear gauge”—sits just above 14. That means investors are continuing to ignore stock market risks and, in the process, are actually assuming even more risk.

All you have to do to see how much risk there is in the stock market is to take a look and see which areas are faring the best.

We are seeing some rotation into higher-risk assets like small-cap, growth, and technology issues. As long as the potential return is high, investors appear willing to assume the risk.

The NASDAQ 100, for instance, closed at a multiyear high of 3,530.76 last Wednesday, easily surpassing its previous multiyear high of 3,502.12 nearly two months ago.

Small-cap stocks have been the life of the party this year, with the Russell 2000 up by more than 20% and achieving three consecutive record-highs at over 1,000.

It’s becoming evident that investors just aren’t scared of risk right now. Even the warning from the Federal Reserve at its June meeting failed to sour the mood, although the stock market did correct by about four percent after the news of an upcoming reduction in bond buying.

When I look at the current situation, I see even greater risk in China and Europe. I also view the future of the U.S. economy as lackluster. And that means the Fed may hold off cutting back on its asset-purchase program for now.

The reality is that this stock market is obsessed with assuming risk in hopes of making some great returns. Investors don’t appear to be able to control themselves, afraid to miss out on any potential gains to come.

While the current euphoric situation reminds me a bit of the Wall Street party in 1999 and early 2000, just before the technology implosion, it’s not quite as crazy. The upward push in the stock market is actually quite orderly compared to those wild days.

But, of course, the investment environment was a whole lot different back in 2000. The federal funds rate stood at 6.24% in 2000, while certificates of deposit (CDs) returned 5.09% over six months and 5.46% over a year. Since there were options in the bond market in 2000, the massive run-up in the stock market looks even more amazing.

Today, the federal funds rate is nearly non-existent at 0.10%, while CDs yield about 0.65% for six months and an even one percent for one year. I’m sure not running to the bank and depositing my money anytime soon. You can understand why the shift to the stock market and higher-risk assets is still happening.

So enjoy the ride. At some point on the horizon, the party will begin to wind down, but now is not the time; in spite of the risk, there’s no real alternative to the stock market. (Read “Why Dow Jones 30,000 Will Become Reality; But What You Should Know First.”)