CEO, Simon Lewis, considers what is currently keeping investors awake at night.
A well executed firework display is a captivating thing. It requires careful coordination of effects must offer a few surprises along the way to maintain interest and must endure for longer than expected before building to a rousing crescendo that leaves a feeling of satisfaction, awe and elation.
This time last year, the above sounded very much like the script for the recovery from the financial crisis. Carefully coordinated action by central banks dazzled with the help of soaring quantitative easing programmes and plunging interest rates and was instrumental in averting an immediate downward spiral. There were plenty of surprises along the way but central bankers remained calm and reacted decisively, and often words rather than action were sufficient to reassure. In fact, this display had got off to such a good start that it looked increasingly certain that the impetus generated by such accommodative monetary policy would enable the global economy to enjoy a sufficient growth spurt to dilute the deadly levels of debt. The story went on for longer than anticipated and faith remained that it would all end well.
However, the mood has changed and fears are rising that the story will end with a whimper rather than a bang. There is now much less room for manoeuvre as the evidence is pretty clear that quantitative easing, after its initial beneficial impact, is no longer able to provide enough bangs for a freshly printed buck.
The problems started earlier this year when co-ordination descended into discord. Greece started by throwing rockets around (Rouketopolemos, which literally means ‘Rocket-War’, is a Greek religious festival that takes place on Easter Sunday). Mrs Merkel and her allies responded with a resounding salvo. The sparks stopped flying but the acrimony and discord left investors feeling jaded rather than elated.
The problems continued with the last minute disappointment of the Chinese firecrackers. China’s massive fiscal stimulus in 2008 encouraged a boom in commodity prices that drove higher levels of economic growth in the emerging world. Rising sovereign and consumer prosperity, spurred on by local currency appreciation, provided a ready market for ailing western economies. It seemed like the show would never end but the incessant cracking and popping became more hesitant and investors began to fret about a premature ending.
The commodity boom was thus transformed into a commodity bust, with the result that the new found wealth of many emerging economies is going up in smoke. It is with some irony that the ‘mine’, a firework that is a popular choice for displays, is defined as follows:
“The effect of the mine firework is short-lived but usually very spectacular: a sudden eruption or burst from the mine at ground level, shooting high into the air before ending abruptly.”
The Chinese firecracker team feels a little hard done by. They would argue that the display relied too heavily on them and that other contingents should raise their game, particularly the Eurozone, who once again were late to light their fuses after yet another long lunch.
To make matters worse, at a crucial stage of the beginning of the end, the Fed appeared to fumble. The US Federal Reserve had performed so well, at outset with a vigorous response to the crisis and thereafter with a carefully tapered exit from quantitative easing. The final task was to give lift off to interest rates, yet provide reassurance that a low arc rather than a high orbit would be the trajectory achieved. However, recent dithering has removed some of the sparkle.
Although the sparkler is a delightful firework, it is often forgotten that for a few seconds after what is left is a piece of almost red-hot wire. The Fed should be careful.
There is a good chance that it will all end well but central banks will need to improve coordination and not be tempted to play the ‘competitive devaluation’ game. In the meantime, many investors have lost a little faith and this has tested financial markets since the summer months. Sentiment is generally negative and markets are susceptible to over reaction until it improves. It might be some time before the sentiment pendulum swings in a positive direction but when it finally does swing, it is likely to be bountiful.
In the meantime, winter is fast approaching and it is always a good idea to wrap up warm if you don’t want to catch cold. For some time, our House View for client portfolios has incorporated a winter coat to fend off at least some of the chill.