We got an unpleasant taste last week of what’s in store when the Federal Reserve eventually starts closing the easy money taps and leaves the markets to their own devices.
All it took to trigger a wave of panic that washed over bond, equity and currency markets around the world was mild musing by the Fed’s printer-in-chief, Ben Bernanke, and some of his colleagues about tapering bond purchases as the U.S. economy improves. The Fed’s monetary policy hawks wouldn’t even wait for better conditions, but Mr. Bernanke and his fellow doves remain firmly in control of the roost.
“If we see continued improvement and we have confidence that that is going to be sustained, then in the next few meetings, we could take a step down in our pace of (bond) purchases,” Mr. Bernanke told a congressional committee. “If we do that, it would not mean that we are automatically aiming towards a complete wind-down.”
Not exactly a headline-grabbing revelation or even a clear timetable for stimulus reduction. As one long-time Bernanke watcher asked: “Honestly, is tapering, and the Fed talking [about] getting closer to it, really news?”
But the spooked market response came as no surprise to veteran strategist Grant Williams, who has long warned that about the only thing underpinning the long global equity rally and the strength of key bond and currency markets has been intervention by central banks on an unprecedented scale to drive up asset values.
“I’ve been doing this for 30 years, and the markets right now are unlike any I’ve ever seen,” Mr. Williams says from his home base in Singapore. “There is so much intervention in all things – in currencies, in bonds, in equities – that the price signals we have traditionally come to use to value risk and allocate capital just don’t work any more.”
The investing world has become so used to this central bank strategy that “a lot of very savvy investors …have been quite literally holding their nose and buying stuff, because it’s been going up.” But everyone knows the day will come when central banks have to cut off the steroid injections. And even the hint of that future withdrawal pain was enough to send markets reeling. “Suddenly, you find yourself having to look at fundamentals again. And the fundamentals look horrible.”
His advice, which he underscored in a speech last week to the CFA Institute’s annual meeting in Singapore, has long been to sit patiently on the sidelines, do the math and avoid being sucked into sucker markets.
“The big problem investors have now that’s really a hangover from 2008 is just a massively compressed time horizon.” says Mr. Williams, a portfolio manager with Vulpes Investment Management and writer of the popular blog Things That Make You Go Hmmm…. Huge losses suffered during the crisis have made people overly eager to get their investments back on track, but with an extremely low threshold for more pain. “It’s the biggest impediment people have to making money.”
And although no one is about to shed any tears for the travails of the Bay Street crowd, the folks who manage other people’s money are in a much tougher spot than the average individual. Unlike their clients, the pros have little choice but to hold their noses and jump into rising markets or risk underperforming benchmarks.
“It’s a good time to invest your own money, as long as you’re comfortable with your time horizon. But it’s a very tough time to invest other people’s money,” says Mr. Williams, who is managing a new precious metals fund but is otherwise focusing on such long-term alternative assets as farmland in New Zealand, the U.S. midwest and Uruguay and real estate in Germany.
“If you have a short-term horizon, then you’re really forced into riding these markets, having one finger on the sell key the whole time.”
For everyone else, the benefits of taking the long view ought to be obvious, he says. Investors should be asking themselves what the world is likely to look like in, say, the next two to three years.
“If you have the luxury to invest accordingly, then being short the market on a three-year view makes sense – as long as you have the latitude to be wrong in the short term, and sometimes painfully so.”
But playing extreme defence in tumultuous times isn’t necessarily going to prevent some sleepless nights.
“A lot of people would have been sitting on the sidelines for the last three or four months watching the S&P make a new lifetime high every day and cursing the fact that they’re in cash,” Mr. Williams says. “If the S&P goes up 14 per cent and you miss out, you’re going to hate yourself. But if in the next month, it corrects 20 per cent, suddenly you look like a genius.”