InvestmentsJan 22 2014

Fund Selector: Living in the shadows

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Five years after the ‘Great Financial Crisis’, this historic event continues to cast a long shadow.

We now live in a world of quantitative easing (QE) – money printing in layman’s terms – and virtually zero per cent interest rates.

It is clear now who is picking up the bill for the biggest financial malaise to hit the world since the Great Depression: it is all of us.

We pay through financial repression – the deliberate suppression of interest rates below the prevailing rate of inflation.

This allows indebted borrowers and governments to reduce their cost of debt to the detriment of savers.

In our opinion, the current period of economic history is unique. We are in the midst of the largest monetary experiment our capitalist system has ever experienced and no one truly knows what the financial landscape will look like when we reach our destination.

Looking at 2014, the key story is likely to be if, how and when the US authorities finally bring their monetary experiments to an end, with the Japanese looking set to continue and the Europeans likely to start brewing their own.

However, the result of this central bank tinkering appears to be nominal growth returning to some areas, namely the US, while others remain decidedly stagnant, such as Europe. The question remains whether the actions taken by central bankers are really leading us along a road to recovery or ruin.

Two of the issues that we believe are critical to their future successes are the massive amount of excess capacity created before the last crisis and the fact that companies are generally in the hibernation of a winter of balance sheet recession, focusing on cost-cutting and repair, over-expansion and investment.

In short, the world still has a demand problem and it is possible that QE is creating that demand problem. Corporations are flush with cash, but by continuing to print money the central banks are signalling to all that we still have a problem. Stop the QE, send a green light that all is well and it is not impossible that the corporates will start investing their cash.

Markets, and specifically sovereign bond markets, are now a key battleground. Bonds have enjoyed an incredible secular bull market that has lasted for in excess of 20 years.

With inflation and bond yields so low and bonds so heavily owned, investors are bound to look elsewhere for income.

If the world is recovering, albeit slowly, money should naturally gravitate towards equities from bonds.

The prospects for 2014 appear finely balanced, but there is no disputing that 2013 has pushed up equity valuations markedly in the developed world.

Risks can be seen from many quarters: a resurgence of inflation, the escalation of political problems, the emergence of emerging market or further European crises, or simply the economic recovery stalling.

However, a continuation of the recovery in the developed world and the associated growth in earnings from companies around the world is also a distinct possibility.

John Chatfeild-Roberts is chief financial officer at Jupiter Fund Management