Bad parenting from central banks
By Carmel Fisher, Managing Director
06 October, 2016
Any investor who enjoys the thrill of finding an overlooked, undervalued gem has had a miserable time of late. Markets haven’t been about individual gems. The focus is back on central bank policy, with the will-they-won’t-they speculation resulting in increased volatility in both bond and stock markets.
As we know, unconventional central bank monetary policies have underpinned markets for some years. We have enjoyed a period of relative calm since the wobbles around the Brexit vote in June.
Recently though there has been increasing concern about the longer term impact of central banks’ involvement in financial markets, and in particular, what happens when they realise that ever lower interest rates aren’t working to stimulate economic growth.
One commentator described a ’distinctly mixed feeling’ in markets during September with ‘more stick than carrot, more push than pull and more frustration than joy’.
We should prepare for more mixed markets and more volatility in coming months, particularly when the US election tension is thrown into the mix.
A columnist’s recent description of the ‘parenting approach’ of central banks helped put their influence on market behaviour into perspective.
In Miller’s Market Musings, Jeffrey Miller discussed what a parent’s goal might be. One answer might be to provide guidance and life lessons so that your children become good people. A near term goal might be for them to be safe, or healthy or happy.
But you probably wouldn’t answer ‘my goal is for my children to always be happy, to never experience pain, or sadness or disappointment. To always get what they want, and to never hear the word No.’
That sort of parent spoils their kids and you know they’re probably going to turn out badly.
Yet central bankers around the world are those parents. The ones you don’t let your kids play with. Those spoiled kids take greater risks and do dumber things because there are never any consequences for their actions.
Miller says the Federal Reserve is encouraging people to do riskier things because they fear upsetting them with a few interest rate hikes and a fall in asset prices. They want markets to be happy and hope that happy markets will translate into a happy and growing economy.
But the bad parents at the Federal Reserve don’t realise that if they take away someone’s ‘safe’ income (by lowering interest rates) they aren’t going to have any money to spend; and forcing them to buy yield producing but-not-100%-safe assets is not going to make them comfortable enough to spend.
Miller suggests the Fed should have raised rates a while ago and markets would have ultimately got used to the idea, just like children get used to hearing the occasional ‘No’.
Continuing his parenting theme, Miller discussed college homecoming parties, saying ‘at some point, most people realise they should leave a party.’ Some have been taught to leave early, when people start to get drunk and obnoxious. Some leave only when they are drunk and obnoxious. Others don’t leave until the cops show up — they’re the ones who get arrested.
‘Don’t be an idiot. Protect your portfolio. Don’t stay at the party thinking you can leave before the cops show up. They always show up eventually.’
I agree with Miller that investors who assume central banks will keep supporting markets are in for a rude awakening. Some assets have become expensive, some investors have overlooked the riskiness of assets, and some have not positioned their portfolios for a quick getaway!
We’re taking care of your portfolios to ensure we don’t overpay, we are mindful of risk, and we are well positioned whatever central banks do from here. But we should be prepared for a rowdy few months – not everyone has the same parenting skills!