10 years after the global financial crisis (GFC) threatened a return to the Great Depression of the 1930s, the global economy is finally on the mend. It is anticipated growth should approach 4% in 2018, the strongest growth since 2011 as the economic recovery gains strength around the world. That means the withdrawal of the extraordinary medicine administered by major central banks since the onset of the GFC will gather pace. The US Federal Reserve will likely lead with further rate hikes and other central banks should also begin moving towards tighter, rather than looser monetary policy.
The scale of the monetary firepower deployed by global central banks via Quantitative Easing [QE] over the past 10 years is breath-taking. Around $10 trillion has been pumped into financial markets, equivalent to almost four times the size of the UK’s economy in 2016. As a result, the Bank of Japan now owns 71% of its local Exchange Traded Funds’ market and over 40% of local government bonds. The Bank of England holds around £435 billion of UK government bonds [28% of all gilts outstanding].
Without these measures the global economy could have collapsed but the sheer wall of money that crashed into financial markets has increased the price of financial assets. Stocks and bonds around the world have soared in value.
Investors were forced into riskier and riskier parts of the market. As the price of government bonds rose, investors moved into investment grade corporate bonds. When those too rose in value, high yield bonds became a target. When they became expensive, investors sought out equities. In effect the rising tide of QE floated all boats, with financial assets rising in value almost irrespective of their individual merits or risk profile.
The turning point in monetary policy has significant implications for investors. It is unlikely markets will sell off but investors should become much more discerning about which assets they buy.
Focus needs to be on the fundamental drivers of an asset price rather than simply relying on a flood of central bank money to lift asset prices higher. Factors such as the outlook for inflation, interest rates, corporate earnings and the quality of a company’s management will become crucial in determining whether a stock or bond offers good value.