What happened in the US to cause a case of the jitters in world markets? Japan was a particular case in point, recently falling 9 per cent over a couple of days.
We knew it was just a question of time before someone put a fly in the ointment of our relatively enjoyable year thus far, but it should not come as a surprise to investors that the Federal Reserve is musing over when to bring its quantitative easing policies to an end.
The policy of suppressing interest rates to stoke up economic activity and avoid a potential depression have been in place for the past couple of years, and have supported risk assets around the world, effectively creating a liquidity fuelled bull market in both bonds and equities. Cash has proved expensive to hold given poor returns and the perilous state of the financial system, providing little alternative but to buy hard assets. The fact that central banks globally have adopted QE as its tool of choice against deflation and recession has just added fuel to the fire.
However, investors do have these policies to thank for providing a cushion to protect markets from too much uncertainty. Recently, they have perhaps made investing rather too comfortable. However, at his latest congressional testimony the Fed chairman, Ben Bernanke, merely stated a hint of a suggestion that time for this support is finally coming under scrutiny in the US. In fact the terminology that if “we see continued [economic] improvement, and we have confidence it can be sustained, we could in the next few meetings take a step down in our pace of purchases”, has initially been taken more poorly than hoped.
In reality it seems more likely that the Fed is testing the water as to the markets’ reaction to a cessation in QE and tighter monetary policy. Given that it has taken a few years to kickstart some economic momentum, it would appear foolish to knock this off track, especially as China’s juggernaut is slowing from an unsustainably high level of growth, and Europe remains either in, or on the verge of, a depression. With global trade unlikely to provide too much support this coming year, perhaps a few words to curtail over exuberance and pricking one or two bubbles in the making is a relatively safer way of steering markets at this time rather than a wholesale change in direction. In fact, a case could be argued for further monetary easing in Europe given that structural/fiscal reform seems as far away as ever.
We have been saying for a while that some bond markets are fully valued and that a number of equity markets look overextended, although not necessarily overvalued. A correction of some kind should be welcomed. The size and duration of a market rally is very often indicative of how sharp, and painful, the fall and so we would hope that an element of fear is just what is needed to provide an opportunity for investors to step back and re-appraise how their investments are currently positioned.
Indeed, it is thought that many institutions and retail investors have yet to step up to invest their assets, and have missed out on some of the gains of the past nine months. If this is the case do not expect to wait too long before markets start to regain their composure.
Nick Skiming is a senior investment manager at Ashburton