Tags: stocks | assets | banks | Fed

Central Banks Drive Asset Rally but How Much Further?

Friday, 25 Oct 2013 11:13 AM

 

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A fresh rally in risk assets fired by expectations of an extended period of loose monetary policy in major developed economies may quickly lose momentum as picking winners in already inflated markets has become much harder.

Record high prices for equities, already tight yield differentials between corporate and government debt and a mixed outlook for commodities have complicated the choices for any investor looking to profit from a simple "risk on" strategy.

When the Bank of Japan joined other central banks earlier this year in boosting liquidity, a broad rally lifted prices across financial markets that only slowed when the Federal Reserve hinted at plans to scale back its own stimulus.

With the timing of Fed "tapering" probably delayed until at least next March after a run of weaker U.S. economic data, hopes of a new rally fueled by easy money have resurfaced. Correlations, the tendency to move in lock-step, between assets has increased.

But this time things look different.

"At this juncture we have got a question mark over risk assets. Credit is fairly valued, equities look a bit toppy and bonds are offering a decent yield," said Daniel Loughney, portfolio manager for AllianceBernstein.

The delay to the Fed's tapering plan, reinforced by weaker-than-expected U.S. jobs data this week, comes as the BOJ ramps up money printing and as central banks in the UK and Europe have promised to keep monetary conditions loose.

The Fed has said the health of the jobs market will be critical in its decision on when to scale back the $85 billion a month it pumps into the system through bond purchases.

The impact of all this cash on riskier asset prices this year has already been dramatic, especially for equities.

Global share prices tracked by MSCI's world equity index are up 17 percent this year to date, on course for their best annual gain since 2009.

The widely-tracked S&P 500 index is at an all-time high, having gained nearly 23 percent this year, while Japan's Nikkei index is up a whopping 35.5 percent.

SELL-OFF AHEAD?

The strong performance will likely turn many investors' thoughts to cashing in, especially as the year end approaches.

"There are so many profits to be realized that I can see a sell-off, not a slump, by year-end in the U.S., UK and Japan," said Alastair Winter, chief economist at investment advisory firm Daniel Stewart & Co.

In the debt markets there are other concerns. The sharp selloff in government bonds that accompanied the first hints by the Fed earlier this year that it was considering pulling back its support reminded many investors of the risks out there.

"The tapering debate has increased awareness of the costs of quantitative easing, namely financial instability," analysts at Bank of America Merrill Lynch said in a note to clients.

At the same time gold, another asset that usually benefits from high levels of liquidity, is having a torrid time.

Though off its lows on the hopes of an extended period of Fed monetary stimulus, it is on course for its first annual decline in 13 years as investors who had bet on all the cash boosting inflation quit the market in droves.

Oil has been increasingly driven by other factors such as the easing of geopolitical tensions, especially over Iran's nuclear program, and improving Middle East oil supplies and it is below the price it started the year.

AVOID LIQUIDITY LURE

Instead of looking to position for a general rise in risk assets on the basis of easy money inflows, investors should focus on their longer-term goals, said Jim McCormick, head of asset allocation research at Barclays.

"To trade these periods, hold on to your framework for searching out value and look to pick up assets buffeted in a risk correlation period," he said.

"Emerging markets have value, the business cycle is picking up and they are probably more attractive than the U.S."

In bond markets, where previous periods of excess central bank money have led to a search for good returns that has lifted most sectors, fund managers expect investors to be more discerning this time.

"There will be a search for yield but people will be more picky," said David Zahn, head of European fixed income at Franklin Templeton Investments, who favors emerging market debt over that from advanced economies.

© 2014 Thomson/Reuters. All rights reserved.

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