Central bank actions have arguably been the single most important driver of market performance since 2009. The turnaround was catalysed by the US Fed’s pursuit of unconventional monetary policy, spawning ‘sons and daughters’ of QE as other central banks hopped on the bandwagon. Since the advent of QE1 (November 2008) the MSCI World Index has roughly doubled in US dollar total return terms, and 10-year treasury yields have been as high as 3.98% (April 2010) and down to as low as 1.40% (July 2012). No wonder investors are on tenterhooks when central bank decisions fall due, and why they scrutinise statements for evidence of future intentions. In the case of the bond markets, central banks have had an explicit policy of driving yields lower across the yield curve and implicitly pushing prices higher, in order to stimulate higher economic activity. In equities, however, policy has been less clear cut, but nevertheless the Fed in particular has spoken about confidence levels and wealth effects being driven by asset prices. It seems reasonable to deduce that they have been supportive of their move higher.
But, inevitably, as economic activity improves, the taps will have to be turned off. And therein lies the rub. Going cold turkey won’t work in a market that has become very fond of virtually unlimited liquidity. In this respect, US tapering is a more nuanced version of stopping QE: in theory stepping down asset purchases weans markets off central bank support a little at a time. But, the beginning of this withdrawal period is something that the world fears – not simply because of the risk of a policy error, but because a return to fundamentals-based investing has to occur. This could greatly affect areas of the capital market that have seen substantial inflows, an effect recently seen clearly in emerging market debt. The pace of economic recovery will differ across countries/regions, so greater care will have to be taken with asset allocation decisions. Making the correct call on fixed income exposure could be one of the most crucial decisions if the outlook for rates changes dramatically
Article by Bill McQuaker, Head of the Multi-Manager Team at Henderson Global Investors