Despite the global economy seeming to be in relatively good shape, Valensie, head of multi-asset at Barings Asset Management, believes that it is indicative of an unhealthy sentiment currently underpinning the market.
He explained: “In the post-financial crisis years, central banks have done ‘whatever it takes’ to curtail market volatility, facilitate access to credit and engage in various types of financial repression, squeezing savers at the expense of borrowers through low interest rates.
“Economic conditions may improve to a point where those policies will have to be discontinued, or even reversed. Once this happens, there is a risk that what has been repressed will come out with a vengeance. Having constrained the cat inside the bag for so long, once the cat gets out there’s no telling what damage it might do.”
Cat out of the bag
Valensie sees September as a likely moment for a US interest rise, and outlined two factors that could prove decisive influences.
“First, there is the desire to re-build interest rates so that they may once again be cut when needed,” he said. “This will give the Fed a critical policy lever in any future downturn.
“Second, there is the need to discipline credit markets, avoid excessive leverage and stop the misallocation of capital.
“Federal Reserve chair Janet Yellen made remarks in early May which resemble the ‘irrational exuberance’ speech by former Federal Reserve Chair Alan Greenspan in 1996. Managing the exit of the cat from the bag will be Yellen’s most important test while in office.”
Valensie believes that an increase in US rates could mark a turning point for emerging markets, which have underperformed developed markets now for some years.
“A strong US dollar and potential policy tightening from the Fed do not bode well for the immediate future performance of emerging markets. However, a turning point might occur as soon as the first rate rise is out of the way and higher interest rates and a strong US dollar get fully priced in the markets. That could be the moment of change.”
“We see a number of factors which seem to suggest an inflection point,” he explained. “Light positioning in global portfolios; commodity giants in Russia and Brazil which have been hit hard; China stocks skyrocketing courtesy of monetary policy; and Asia being a major beneficiary of the oil price fall.
