The Federal Reserve has for some time been trying to alter the communications it has been making to markets about the likely path of policy in the US.
The first utterances were on May 22 when the market interpreted Fed chairman Ben Bernanke’s comments to mean that quantitative easing (QE) may begin tapering earlier than expected, which may also bring forward the day that interest rates will also move upwards.
To many investors, this came as a bit of a surprise as US economic data had been pretty stodgy and the consensus was Mr Bernanke would not tighten policy until the economic recovery was definitely in place.
Furthermore, he is a great student of the 1930s depression when the Fed managed to kill off a nascent recovery by raising rates too early in 1937. The result of this surprise was the inevitable sell-off that we seem to get in most Mays.
Fast forward to June 20 at 10.46am – the date and time I am writing this – and markets are once again getting themselves into a bit of a tizz about the speech Mr Bernanke delivered the night before, which confirmed tapering was likely to start in 2013, with rates moving up sometime in 2015. A diversified portfolio that contains government bonds, equities and gold will be losing money in each of these areas.
We believe there are some interesting points that need to be thought through. Firstly, tapering is reducing the level of QE, not ending it.
In essence, rather than removing the punch bowl, Mr Bernanke is diluting it – to extend the metaphor further, the party can go on but it may not be so much fun.
The next point to think about relates to the type of investment strategy required for what will be a different environment. Declining interest rates through monetary policy saw assets with secure yields prosper.
In the equity market, this meant equity income favourites – consumer staples, pharmaceuticals, etc – did really well, even in positive markets.
If the new environment is for rates to rise – albeit in the future – then maybe the leadership of the market will also change away from these bond proxies and more towards areas of the market that are cheap and benefit from some economic growth, such as cyclicals.
For a while now, we have been champions of the idea that western economies could be the leaders for the next decade, which may also see a resurgent dollar, and our conviction has not changed.
If we are correct in our analysis, then this may have some negative implications for emerging markets, so the recent trend of developed world markets outperforming could continue. We would suggest Japan and Europe are the cheapest and therefore best ways to play this.
Gold has been a good asset to own while there have been low interest rates and excessive printing of dollars, but both these trends have reversed and the precious metal may no longer be so relevant for investors’ portfolios.
When the direction of monetary policy changes, all markets take a while to digest the implications of the shift. Bonds, equities, property and commodities may decline together for a while, but this will create opportunities for those investors who have been willing to hold cash to sidestep such weakness and then can carefully pick up the winners of the next investment cycle.
Marcus Brookes is head of multi-manager at Cazenove Capital Management
