During a flight to safety, risky equities like growth stocks are often some of the first to fall in price.
What Does Flight to Safety Mean in Finance?
Flight to quality (or flight to safety) refers to the tendency of investors to move their money out of riskier asset classes (like technology stocks) and into more stable asset classes (like government bonds) during bear markets, recessions, periods of high inflation, and other times of economic uncertainty.
Flight to quality is a bit of a misnomer, as lower-risk asset classes aren’t necessarily higher quality than higher-risk investments—they’re simply less volatile. For this reason, flight to safety is probably a more accurate term, as the less volatile an asset is, the safer a place it might be to park one’s cash during periods of instability. That being said, the two phrases are used interchangeably, and both refer to the mass migration of investor cash toward lower-risk, lower-return assets during market downturns.
What Does a Flight to Quality Look Like in Practice?
A flight to safety is generally the result of the so-called “herd mentality” that tends to dominate Wall Street. During a flight to quality, investors are more worried about protecting the wealth that they have than they are about growing it via the purchase of speculative assets with the potential for high returns.
A somewhat sustained downturn in stocks after a long bull market, for instance, can scare the market’s most prudent investors into selling their riskiest assets to protect their gains. This can drive the prices of those assets slightly lower, inspiring even more investors to sell in subsequent waves of capitulation.
In general, the riskiest investments—the ones investors abandon first during the early stages of a flight-to-quality event—include derivatives like options contracts and higher-risk stocks like those of recent IPOs and newer tech companies that have yet to turn a profit. At this point, many investors might move their money to value ETFs and blue-chip stocks—those with a longstanding reputation for stability and dividends.
From here, if the downturn continues, some investors may abandon stocks in general, instead investing in even more stable instruments like bonds and money market funds. Extremely risk-averse investors may even turn to holding only cash and short-term cash equivalents, even though this could mean incurring a negative real rate of return due to inflation.
How Does a Flight to Safety Affect Different Asset Classes?
The prices of different types of assets are primarily the product of supply and demand. When more investors want to buy something than sell it, its price goes up, and vice versa.
As one of the most volatile asset types, equities tend to go down in price during a flight to safety. The prices of riskier stocks—like smaller or newer companies, discretionary stocks, growth stocks, and those in the tech sector—tend to fall first, faster, and more significantly than those of older, larger, more stable companies.
As investors sell stocks and buy bonds, bond prices go up due to increased demand. This causes bond yields to fall. Additionally, higher interest rate environments tend to be associated with higher bond prices and lower yields. Many analysts watch for rising bond prices as a possible signal of continuing economic decline.
Some investors believe that gold (along with other precious metals) is even safer than cash during periods of high inflation and decreased purchasing power. Critics argue that gold lacks inherent value, but many conservative investors do still purchase gold during downturns, and this can cause its price to rise.
Other commodities, such as grains and oil, react in more nuanced ways to downturns in the stock market, and their prices are far more sensitive to global developments than the prices of stocks and bonds, so their price movements can be more difficult to predict during a national flight to quality.
The following are descriptions of phenomena closely related to a flight to quality in investing.
What Does Flight to Quality Mean in Real Estate?
In the real estate market, flight to quality means almost the same thing as it does in traditional investing circles.
When the real estate market begins to experience a downturn after a period of prosperity, prudent real estate investors flee higher-risk real estate investments—like opportunistic real estate that involves new construction in newly developed areas and value-add investments like properties that require significant renovation—and flock toward what are known as core investments. These are established properties in good condition in areas that are already established and well-occupied.
What Does Flight to Liquidity Mean?
A flight to liquidity occurs when, due to market uncertainty or a sudden panic, investors attempt to liquidate their investments en masse, putting their money in cash or cash equivalents so that they can quickly reallocate it once the panic ends and a trend is established.
Flight-to-liquidity events are often shortlived compared to flight-to-quality events, as investors tend to reinvest their cash quickly once they have a solid idea of what the market looks like and how much risk they are willing to take.
Flights to liquidity typically occur when it seems like the market is “on the brink” of a potentially important change or event—for instance, when the United States approaches its debt ceiling, and it is unclear whether the debt ceiling will be raised to prevent default, some investors liquidate many of their assets until a decision has been made.
What Does Flight to Value Mean?
Flight to value can be thought of as a sort of a subcategory of flight to quality. In the stock market, value investors (like Warren Buffet) prefer to seek out stocks whose fundamentals imply that they are undervalued. During a flight to value, investors may sell speculative technology and growth stocks and instead purchase stocks with solid fundamentals like low price-to-earnings ratios.