We see risk in three key measurables: volatility, correlation and liquidity. Liquidity is often ignored, as it’s harder to measure, but it can often prove the most important risk.
A way of considering the financial system in the post-quantitative easing (QE) era has been to understand that everything has become increasingly dependent on confidence in central bankers.
So long as markets believed debt levels no longer mattered, and countries could grow their outstanding debt without consequence, the show could be kept on the road.
Many years ago, we described quantitative easing as battlefield medicine, quite necessary at the time, but with a real danger of addiction if not exited early. Ten years after its introduction, attempts to exit QE are proving more problematic for the US than policymakers may have expected.
For many years, financial markets have had a very benign backdrop. The era of quantitative easing put a floor under bond markets, forward guidance provided certainty over future US interest rates, and we had a relatively predictable political order.
These factors, combined with a growing economy and ultra-cheap money, may have given rise to a huge degree of complacency in financial markets, or irrational exuberance as it was once termed.
In all big stories, the reality is often more nuanced than headlines suggest and the growth versus value debate is no different. It’s true that growth stocks have recently outperformed by a considerable degree and this had led to a degree of comparison with the tech bubble in the late nineties, as relative performance has reached these heights. Back then, the reason for growth’s outperformance was a high level of speculation in a narrow area, which had little or no earnings.
The global economy is transitioning from a long period of falling inflation and interest rates to one of gradually rising inflation and interest rates. While we don’t think we’ll see this shift occurring rapidly, we do think the disinflationary forces of the past few decades are now fading or even reversing.
We don’t often cover the topic of currencies, given that as a rule we endeavour to keep the level of currency risk in our portfolios contained. This is on the basis that currency moves are relatively unpredictable and there’s no long-term expected return from an overseas currency. However, from time to time markets appear to bake in a consensus that seems inconsistent with the facts.
Having seen many of the large, historically successful countries fall to supposedly weaker opponents, the lesson is to carefully consider all possible outcomes rather than apply a high degree of certainty to your preferred or expected outcome. The odds of an underdog winning a football match are much higher than we believe, just like the chances of an investment view coming right precisely as you expect are much less than your instincts lead you to believe.
Valuation of bonds has become distorted due to seemingly indiscriminately buying.
Chinese internet stocks could be less risky than western says David Jane, manager of Miton’s multi-asset fund range.