Have the world’s central banks robbed future returns from the markets?
The Bad News
Since the financial crisis of 2008, the world’s major central banks have intervened in the global markets to an unprecedented degree. This extraordinary level of monetary stimulus was intended to lift economic growth indirectly by first raising asset prices, in the hope that renewed “animal spirits” and an accompanying wealth effect would result. While central banks were successful in raising asset prices through quantitative easing (printing money), a satisfactory level of economic growth remains elusive. Therefore, with asset prices climbing more quickly than underlying economic growth, central banks may have robbed from potential future investment returns by pulling gains in asset prices into the recent past. This could mean that going forward, markets may face the prospect of investment returns that are lower than historic norms, particularly on a risk-adjusted basis. As a result, a simple buy and hold strategy of owning stocks and bonds may produce disappointing returns, while short-term trading strategies could also prove to be counter-productive since investors may be whipsawed by market volatility.
The Good News
However, even if investors are faced with a low return environment in the future, there may still be ways to seek to generate attractive risk-adjusted returns without necessarily increasing risk or reducing liquidity. Since markets don’t tend to move in a straight line, even if we experience returns in the future that are below historic norms it doesn’t mean that all markets will simply bump along at some low level of returns each year. Markets tend to move in cycles, particularly at the asset class level, because they are part of a complex system of interrelated factors, much like systems found in science and nature. Complex systems tend to fluctuate from one extreme to another and they are rarely in a state of equilibrium. In market terms, this means that equity, bond, currency and real asset markets also move in cycles and also tend to fluctuate between overvalued and undervalued. Therefore, an opportunity exists to generate attractive long-term investment returns by seeking to identify those undervalued asset classes that may be poised to enter a period of outperformance by recognizing the economic, fundamental and behavioral factors (including the actions of the world’s central banks) that could drive market cycles in the future, particularly at the asset class level.
Risk Management Remains Important
Going forward, it will also be important to recognize that since the world’s major central banks have taken the global capital markets into uncharted territory, investors may face risks unlike those experienced in recent history. Given a world of unusually low interest rates, excessive government debt, extraordinarily weak monetary policies, low global economic growth rates and rising geopolitical tensions, investment portfolios will need protection from a variety of “fat tail” or “black swan” events. This includes vigilance against deflation as well as inflation. This is why our research extends as far back as 1871 in order to capture and study market dynamics that included periods of deflation, rapid inflation, currency wars, depressions and world wars in an effort to manage portfolio risk more comprehensively, while seeking to deliver attractive risk-adjusted returns.
It may well turn out to be the case that, going forward, investors will be faced with a period of generally low investment returns as a result of the world’s central banks having pulled returns forward through aggressive use of monetary policy. However, it will be possible to generate attractive risk-adjusted returns by seeking to identify undervalued asset classes that may be poised to enter a period of market outperformance.
DeFred G Folts III
Chief Investment Strategist
DISCLOSURES: The observations noted above are not intended to provide personal investment advice and do not take into account the unique investment objectives and financial situation of the reader. Investors should only seek investment advice from their individual financial adviser. These observations include information from sources 3EDGE believes to be reliable, but the accuracy of such information cannot be guaranteed. Investments in securities, including common stocks, fixed income, commodities and ETFs, involve the risk of loss that investors should be prepared to bear. Past performance may not be indicative of future results.