Tuesday, 8 July 2014


The second quarter of 2014 ended with positive, albeit somewhat pedestrian investment returns. For UK investors, the rise in the value of £-Sterling by a near double digit rate, took some of the shine off overseas investments. Year-to-date (Ytd) lower risk, fixed interest investments have still generated slightly higher returns than higher risk equity investments.

This is very much at odds with last year's picture, when equity dominated investment strategies outperformed fixed income strategies at a rate of 3:1. Despite this, the first days of the new month and quarter have seen a surge in stock markets around the world as various economic news items persuaded investors that equities may have more upside potential than recently thought. On the one hand much improved industrial output and falling unemployment figures in the US and UK provided more evidence that the Q1 slip was indeed caused by adverse weather and not a reversal of sentiment. Just as important for market dynamics were comments from 3 of the 4 major western central banks (US, Eurozone, UK), that they would not let excessive market valuations dictate monetary policy for the real economy. I.e. they would not raise rates even if perceived asset bubbles started to build. Markets would have to deal with the volatility they seed and central banks would use their macro prudential intervention tool sets (E.g. mortgage restrictions et al) to prevent turbulence spill over from becoming a systemic threat for the financial sector. What felt like a concerted action by the central bankers (which probably was not), combined with the reassurance of the sustained growth scenario acted as a jolt for the lacklustre stock markets of late. US stocks hit new all-time highs while UK and Eurozone markets reclaimed previous 2014 highs. Central bankers may have felt obliged to clarify their position after the Swiss based Bank for International Settlements (BIS) called for a hike in interest rates. This was to prevent further asset price increases, which they see as being driven by the continued low interest rate and QE driven monetary environment. The BIS is often portrayed as the 'Central Bank of Central Banks' although it's role is more that of a global central banker association rather than having meaningful authority towards national central banks. The BIS has changed tack from warning about the inflationary pressures of QE to warning about the destabilising potential of asset price inflation. With deflation currently being the far more relevant issue, it feels as though we are witnessing a growing divide between 'Germanic' and 'Anglo Saxon' central banking perspectives. From my standpoint I side with the 'Anglo Saxon' side, with a focus on getting the real economy properly back on the growth track, while using regulatory oversight measures to reign in potential excesses in the financial sector. To be clear, the 'near death' experience of the 2008/2009 Financial Crisis is in my opinion likely to prevent bank excesses for the foreseeable future on its own (See UK banks own mortgage tightening long before the BoE became active). The so called shadow banking sector of credit and loan securitisation for investment by the general public is a slightly bigger concern, because the decision makers here are not finance professionals. It is therefore not surprising that the US Fed's chair Janet Yellen singled out leveraged-loan debt securities and corporate bond valuations as areas where macro prudential oversight measures may be used to prevent potentially destabilising market developments. 

To summarise: As the expansion of the global economy picks up momentum again, company earnings will improve which helps justify higher stock market levels and thereby investment portfolio gains. As a side effect and late rumble of the financial crisis, the unusually low interest rate levels at this stage of the cycle, have the potential to confuse valuation measures compared to the very straight forward metric just mentioned. This is highly likely to result in more volatile asset prices than we are historically used to. Temporary overshooting and undershooting within the longer term positive trend of an expanding global economy is going to be an on-going market characteristic for the foreseeable future. Itwill be quite risky to anticipate and even out from a portfolio management perspective. At Tatton we will do our best to steer client's investment portfolios through these choppy markets, but have to advise that investors are likely to have to withstand having to bear more short term ups and downs in order to reap the longer term higher return rewards of capital market investments, than they may have been historically used to.

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