Not a lot has changed in the investment world since our last Compass in late June.
Stocks went up and then down a bit; commodities went down and then up a bit; bonds went down and then down a bit more. If there was a unifying theme to the background noise, it was investors’ evolving views of central bank policies and their implications.
Residents of the United States, please read this important information before proceeding
As we move into the final third of the year, we continue to see the prospective tapering of quantitative easing (QE) at the Federal Reserve – and perhaps the revealed limitations of “forward guidance” on both sides of the Atlantic – as a welcome step on the road towards monetary normality.
Plausible discount rates are a key thread in the fabric of free enterprise: businesses and consumers need some way of gauging what a reasonable reward for investing or waiting might be. The large gap between the recent cost of funds to governments and central banks on the one hand, and the risk-adjusted rate of return generated by quoted sector business assets on the other, is an understandable consequence of the crisis. But it is unhealthy and unsustainable.
We continue to think that developed equity markets offer better prospective risk-adjusted returns than bonds, both tactically and strategically
If the major Western economies are, as we suspect, capable of standing on their own two feet once more, the supply of cheap money – and the demand for safe-haven assets – will fade. If central banks don’t move, capital markets may act for them. Not everybody shares this glass-half-full view of the developed world economy, and it is a safe bet that nerves will be stretched as data and central bank comments ebb and flow. Meanwhile, some commentators fear that the looming German election, and/or any number of political developments elsewhere in the eurozone, may yet spark the still smouldering euro crisis back into flame. Wider geopolitical risk is also all too visible in the tragic events, again, unfolding in the Middle East.
Nonetheless, as we see things, ongoing economic growth is not dependent on central bank support, but still-high bond prices probably are. We also think that those eurozone risks are containable, and that the narrow economic implications of what is happening in Egypt and Syria are limited, despite the high cost in wider, human terms.
As a result, we continue to think that developed equity markets offer better prospective risk-adjusted returns than bonds, both tactically and strategically. For clients who are currently under-invested in stocks, and whose financial circumstances and personalities permit, we advise keeping this point in mind in the noisy weeks ahead.
Chief Investment Officer, Europe