By Mark Burgess
In the five years since the onset of the global financial crisis, markets, economies, and the authorities have taken many opportunities to surprise and confuse investors. The recent policy initiatives introduced by the Bank of Japan (BoJ) are the latest in this long and bewildering chain of events as central banks attempt to offset the many and varied deflationary forces brought about by deleveraging and the accompanying austerity measures.
Having been hitherto staunchly conservative, investors are rightly stunned at the scale of Japanese QE, where the central bank has started a programme of stimulus on a massive scale. Where the Fed may have surprised investors initially with its programme of $85bn a month, or 7% of GDP, the BoJ has trumped that with its programme of 15% of GDP, an unprecedented move. This will see it buying 1.6-times net supply, completely and deliberately crowding out traditional investors and swamping the markets with further liquidity. This has not surprisingly seen the yen fall sharply, and has prompted a big stock market rally. The intention of the BoJ is to end 20 years of deflation and get inflation up to 2% per annum by forcing investors out of bonds and into riskier assets. It will also force domestic Japanese investors to look overseas for their returns; with the prospects of a non-existent bond yield, and a depreciating currency, why wouldn’t they seek a return in higher yielding foreign bond markets? Faced with a decline in domestic population of 30%, I suspect the reflationary policies will ultimately fail, but at least the authorities are giving it their best shot.
The irony is that the underpinning this gives to risk assets feels at odds with both fundamentals, and leading indicators. Equity markets have performed well this year, but earnings revisions have turned negative and growth prospects have been downgraded, both for corporates and for sovereigns.
Within equities, cyclicals have underperformed defensives, emerging markets have underperformed the developed markets and commodities have been under pressure. It doesn’t feel like the backdrop to positive equity returns. Within Europe the recent Cypriot bailout is an additional reminder as to the fragility of the eurozone and its financial system, and is a worrying precedent for the periphery as to what the future may look like. Indeed, it runs the risk of undermining the banking system further by prompting deposit flight from the domestic banks. Growth appears to be difficult to come by, and the recent downgrade to growth expectations in France is the latest disappointment to hit the region.
But if investors have learnt anything over the last couple of years, it is that despite anaemic growth, faced with a tidal wave of developed world QE, they ultimately have nowhere to go other than equities, not least of all because of the yield pickup offered by this asset class. It should perhaps come as no surprise that in nearly all regions of the world, the income and higher yielding strategies have been the best performing. As long as the central bank taps are turned on I expect this trend to continue.
Mark Burgessis chief investment officer at Threadneedle Investments
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