Snap, Crackle and Pop

I used to love the snap, crackle and pop of the Kellogg’s Rice Krispies as I poured milk over what was my favourite childhood breakfast cereal.

I had a similar but less pleasurable experience this morning, but no Rice Krispies were involved. I was catching up on what had been happening in Asian stock markets overnight and looking at the implications for the opening of the London Stock Exchange. It was clear that, following the lead set by the New York and Chicago exchanges yesterday, global stock markets were headed south at a greater velocity than has been experienced for some time. The news feeds were snapping, crackling and popping with predictions of financial Armageddon.

However, a stock market retrenchment of this type was not unexpected. It has been obvious for a number of years that asset prices have been lifted by the impact of quantitative easing and that, when this unprecedented and so far successful monetary policy experiment finally went into reverse, the pressure on prices would change direction.

In recent months, stock markets have risen strongly to reflect the much improved outlook for the global economy. There is a clear and synchronised economic recovery in progress and the recent tax cuts in the United States will only serve to boost economic activity. This will be of benefit to companies and their shareholders.

All of this good news comes at a price. The global economy is recovering and inflationary pressures are building. What will inevitably follow is a need for central banks to tighten monetary policy, which means further increases to interest rates. Just as the economic recovery gets into full swing, the cost of borrowing will be increased to stifle demand. It has been apparent that markets have been underestimating the rate at which interest rates might increase and the market falls we are now witnessing are a consequence of this sudden but nevertheless belated realisation.

There is a lot of talk of bubbles, but not all bubbles pop. I am confident that we are simply seeing what happens when a bubble deflates and, as we make further progress towards the normalisation of monetary policy, we should expect plenty of inflation and deflation along the way. That is a much better scenario than stock markets ignoring reality and continuing to rise, only to fall much heavier in the future.

In the long run, investors should not panic as there remains plenty of opportunity for good returns; but we should all expect a little turbulence in the months and years ahead and it is in times like this that a well-considered and diversified portfolio earns its keep.

I am pleased to report that the defensive characteristics of PMW client portfolios’ are acting to suppress volatility, so our clients can continue to feel confident about their finances.