This news follows official data from the Bank that showed CPI in January hit 0.3%, the lowest imprint since records began.
There is typically a disconnect between what the general public think of inflation and what the actual data says. But, both pieces of data would seem to suggest that rates in the UK are unlikely to go up anytime soon and, perhaps more importantly, as Hermes chief economist, Neil Williams said last week: “the sink of money will remain full for the foreseeable future, even though the taps have been turned off.”
The problem with this is that the while the contents of that QE sink have been clouding the investment waters for the last five years, many investors had begun to convince themselves that, with the ending of the Fed’s money-printing experiment and the increasing likelihood that US rates could rise in June, the prospect was for slightly less murky water ahead.
If we assume this is unlikely to be the case, then the prospects for investors attempting to navigate said waters remains poor and the likelihood of running ashore on a sandbank (to stretch this metaphor to breaking point) increases.
As David Jane, head of multi-asset at Miton put it: “We have got to a point where the theoretically lowest risk assets offer either very low, or even negative, returns while the theoretically higher risk assets appear to offer relatively high returns. So everything appears to be normal until you dig a little deeper.”
According to Jane, the potential for loss in the lowest risk assets (especially short-dated government bonds) is much greater than those offered by the highest risk assets (for example smaller companies).
This is the perverse effect of QE, he said: “By creating a one way bet in government bonds, through central bank bond buying and a determination to keep rates low, bond investors have been right to consider themselves underwritten on the downside. Credit investors have also been experiencing extremely low losses as the authorities stepped in with QE to prevent widespread defaults in the last recession.”
While an increasingly widely held view, it does go against the received wisdom in the first few years of the QE, that it was equity markets that were being propped up by quantitative easing.
Where to look
For some, like European Wealth investment strategist Richard Stammers, the asynchronous risk reward profile on traditionally low risk assets means he has removed all exposure to the asset class for his lowest risk clients.
“The risk we were taking for the reward we were getting was like running onto the motorway to pick up coins,” he said. For his lowest risk clients he has moved much of the money into cash plus funds where the focus is return of capital rather than return on capital.
Jane agrees pointing out that there is a material risk of a parallel upward shift in the yield curve when short term rates do eventually rise.
Such a scenario would lead to sharp capital losses for bond investors, he said.
Jane, however, adds: “if our thesis is correct, that money has been attracted to seemingly low risk assets because of high rates of capital gain at the expense of higher risk assets, this eventual ‘normalisation’ could prove beneficial to both the prices of riskier assets and the normal operation of capital markets.”
This seemingly counterintuitive view is one shared by Kerry Craig, global market strategist at JP Morgan, who believes that perhaps instead of asking whether or not equity valuations are prohibitively expensive, rather they should be asking, why not invest in equities?
“Yes equity valuations are high,” he told Portfolio Adviser, “but a lot of the negative events that might have happened have yet to materialise.”
“The Fed continues to provide guidance on what it is thinking, European economic data continues to surprise largely on the upside, Greece remains in the union, banks continue to deleverage and, the protection offered by bonds is now lower than ever.”
Craig currently points to cyclical sectors as a place to look as the valuations of defensive stocks have been driven up by the continued hunt for yield and cyclicals should continue to benefit from the lower oil price.
However, he added, increasingly, it is important to approach investment in a nuanced manner and, as a result, alternative strategies, are likely to become increasingly important.
“With asset prices across the board at elevated levels, it is increasingly important to find investments that actually provide diversification,” he added.
Michael Spinks, co-head of the Investec Asset Management multi-asset team says it currently holds gold, infrastructure and reinsurance in its uncorrelated bucket, but adds, it is difficult to find uncorrelated assets at certain points in the economic cycle.
“We have to work harder to find these assets, but with the use of relative value investing, where we take a relative view of one asset/market versus a related asset/market, we can remove directionality from the equation, to provide uncorrelated exposures,” he said.
He added that the firm currently takes active currency positions, some of which can be regarded as uncorrelated.
For example: “we are long the Hungarian forint and short Polish zloty. Both countries are exposed to similar external factors given their geographical location, so this play exploiting the relative attractiveness of one country versus the other is therefore focused on their respective domestic characteristics instead, which are less related to global economic growth drivers.”
As the prospect of the abnormal remaining the normal for the forseeable future, a resignation seems to be setting in. A view that perhaps, there is no alternative to equities because the other options are even worse. But, perhaps a better view might be, get as many alternatives as one can find.
