By Ad van Tiggelen
In financial markets, the start of 2013 was a study of extremes. Investor optimism was high and equity volatility low, pointing to a perceived absence of risk. At the same time currency markets were on fire and the media continued to use the word ‘crisis’ in every second sentence. These contradictory observations beg the question: have risks indeed been sufficiently eliminated, or have investors just listened too long to the central bank lullaby?
In 2011 and 2012, global central banks strongly reduced the risks of a systemic breakdown. The most aggressive ones have even been able to help engineer a certain amount of growth. Recently, they have been so successful that an innocent observer might think all is well in the world. Equity investors have apparently listened long enough to their printing press lullaby to largely forget about risk. And understandably so, as central banks have not only brought stability but have also pushed interest rates extremely low, almost forcing investors into higher yielding asset classes.
‘Luckily’ we have the media to remind us that Europe is still in a crisis. For them, good news is no news. Columns with a negative tone generally met with a higher take-up by the European media than those with a brighter view on the world. This preference for showcasing drama is one of the factors depressing consumer confidence. However, investors do seem to care less. They now look beyond what is happening in Europe to what is driving the global economy as a whole, a playing field where actions of central banks remain pivotal.
How pivotal these actions are was evident again in January. After the successful stabilisation operation in previous years, the focus has now firmly returned to growth. And higher exports through a competitive currency-devaluation are seen as the most direct route to achieving that growth. In January the Japanese yen almost lost 9% against the euro. The pound lost 6% and the US dollar 3%. That is largely so because the central banks of these countries (are expected to) print money faster than the ECB. Much faster. For Japan this is a significant break with the past, in a final attempt to escape the deflationary spiral which has haunted this aging country for so long. For the US and UK it is just ‘business as usual’.
The flipside of this development is that the ECB, the central bank which has expanded its balance sheet less fast than others, is not only governing a region which is still struggling to achieve growth but also has to cope with a currency which is at risk of becoming too strong. If this trend continues the ECB may be forced to lower interest rates even further and/or make a less conservative use of the printing press.
What does this mean for investors? Firstly, short-term interest rates in the eurozone will remain extremely depressed and may possibly even go lower. Secondly, the strong rally in equities since the summer has eroded some of the valuation support for this asset class, certainly in the US. Further gains from here on may therefore feel more like an uphill struggle, also given the modest outlook for profits. We still like equities, but less so than in the past months. Finally, in financial markets where positive surprises in central bank behaviour have proven to be major catalysts, Japan could well provide the most popular ‘lullaby’ of 2013.
Ad van Tiggelen is senior investment specialist at ING Investment Management
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