As recently as mid 2014, Bank of England governor Mark Carney was dropping subtle and no-so-subtle hints that he had an eye on an interest rate rise before the year was out.
Fast-forward to today and economists are queuing up to push back their calls on a UK interest rate rise to as far as 2017 following the release of the Bank of England’s latest inflation report. In fact some are talking about a rate cut and return to QE.
“The Bank of England may not be showing much concern over stalling inflation, as low food and oil prices are generally considered to be supportive of economic growth, but there seems to be grounds enough for the dovish members of the central bank to be even looking at an interest rate cut,” said Nick Dixon, investment director at Aegon UK.
“The threat of deflation, together with sterling’s gains against the euro, have created an unexpected challenge for the BoE, and we could see a 0.25% interest rate, and even a reinjection of quantitative easing, before the year is through,” he added.
With monetary policy always being a key factor in the performance of all asset classes in one way or another, investment has become a shorter term game than arguably ever before. Can many investors really be expected to hold their nerve on a 5, 10 or 20 year plan anymore when they see such fundamental shifts occurring over six months?
Only a few months ago much of the talk around the investment industry was how to best position portfolios for an imminent rate hiking cycle in the UK and US. However anybody that locked in positions that cannot easy be changed on the assumption that we would see an interest rate rise in the UK during early 2015 has been well and truly burnt by the events of the past three months.
The big joker in the pack of course has been the oil price collapse, which is now feeding into real economies at pace, kicking the legs from beneath any monetary policy hawks, who had been growing steadily bolder until the dollars per barrel number went haywire.
However it is perhaps too simplistic to blame everything on OPEC and Saudi Arabia’s desire to put US fracking companies out of business. The central bankers themselves, more specifically the media focused brinkmanship of the likes of Mark Carney and Mario Draghi, has played a role in the wild economic swings seen over the past half year.
There has also been a collapse in certain aspects of established economic theory which for decades had been used by investors to formulate their strategy and asset allocation, such as what a given level of the M4 money supply meant for the economy.
“When we consider the size of the Bank of England balance sheet and how it’s expanded so significantly, it’s almost bewildering to think we’re wrestling with deflation, [or] certainly in a strong disinflationary environment,” said James Sullivan, CEO of Coram AM.
Sullivan also noted that if the UK does slip into deflation as is looking increasingly likely, equities investors will need to make a rapid shift in their portfolios, with value stocks being the order of the day. “So show me an equity market that performs well in a deflationary environment. It’s not too common, in fact, it probably doesn’t exist. Deflation cuts clean through equity markets, and it’s likely to cut pretty deep when the starting point is a high price earnings multiple. If one has skin in the game, which I accept we must in order to maintain our status as ‘investors’ – I believe it’s far more sensible to buy lower PEs to at least offer some comfort there isn’t as far to fall, and buy robust value sectors where the dividend stream is covered, sustainable, and will help cushion capital volatility,” Sullivan said.
If you did this of course, you cannot discount the possibility that a radical rethink will be required again in six month’s time.
The alternative is to ride out the storm and keep assuming you will make money over a 5 or ten year timeframe if you hold your nerve. This is increasingly asking too much of most investors though.