Risk-On vs Risk-Off: Sentiment and Safe Havens

What you will learn

• What risk-on and risk-off mean.
• Which assets are often seen as safe havens and why.
• What correlation is and why it changes over time.
• Why diversification can work less well in a sell-off.

Explanation

Sentiment is the general mood of investors. When they feel confident about growth and earnings, the mood is risk-on: money tends to flow into stocks, especially growth stocks, crypto-assets, emerging markets and currencies linked to growth and commodities (for example AUD).

When investors become worried, for example about a recession, a crisis or a shock, the mood turns risk-off: money tends to flow into safe havens, assets that are expected to hold value better in stress. Common examples:

• High-quality government bonds such as US Treasuries and German Bunds.
• The US dollar, the Japanese yen and the Swiss franc.
• Gold.

"Safe haven" does not mean "cannot lose". These assets can also fall, and the haven that works best changes from one episode to the next. For example, if a shock comes from rising inflation, bonds may fall together with stocks.

Correlation measures how two assets move together, on a scale from −1 to +1. +1 means they move perfectly together; −1 means perfectly opposite; around 0 means no clear relationship. Correlations are calculated from past data, so they describe history, not the future.

Why correlations change: the main driver of markets changes. When growth worries dominate, stocks and bonds may move in opposite directions. When inflation and rate worries dominate, they may fall together. In sharp sell-offs, many risky assets can fall together as investors sell what they can to raise cash. This is why diversification can protect less than expected exactly when you need it most.

Common signs of risk-off: stocks falling broadly, yen and Swiss franc strengthening, government bond yields falling, volatility measures rising, and crypto-assets falling sharply.

Worked example

Hypothetical example: a portfolio of €10,000 is split into €5,000 in a stock fund and €5,000 in crypto-assets. The investor assumes they are "diversified". Then a risk-off week arrives. Fees and taxes are excluded.

1. Stock fund falls 4%: €5,000 × −0.04 = −€200.
2. Crypto falls 10%: €5,000 × −0.10 = −€500.
3. Total: −€200 − €500 = −€700.
4. Portfolio change: −€700 ÷ €10,000 = −7%.

Both holdings were risk assets, so in risk-off they fell together. Holding two different assets is not the same as holding assets that react differently to the same shock.

Common mistake

Practice activity

On paper: classify each hypothetical market move as more typical of risk-on or risk-off: (a) stocks up, AUD up, bond yields up; (b) stocks down, yen up, bond yields down; (c) gold up, Swiss franc up, crypto down. Then explain in one sentence why classification (a) could also fit a different story.

Key takeaways

• Risk-on favours stocks, crypto and growth currencies; risk-off favours safe havens.
• Safe havens can still lose value, and the best haven varies by situation.
• Correlations are historical and change when the main market driver changes.
• Diversification can weaken in sharp sell-offs; plan for that.

Next step

In the next lesson you will build a simple weekly macro routine that uses this knowledge without trying to predict.