Annualised performance data in euros at 30th April 2023.
The key takeaway from the ECB President’s recent speech in our view is that central bankers will continue to intervene in markets to ensure they fulfil their primary objective of delivering price stability. This means that during inflationary periods, they will tend towards increasing interest rates and reigning in growth in the money supply, where possible, to control inflation, acting as the market’s ‘bad cop’. During periods of weaker growth and falling inflation, they will intervene to lower interest rates and increase the money supply to encourage more risk-taking behaviour, acting as a ‘good cop’.
Now, it’s always easier to act as a ‘good cop’ and print than a ‘bad cop’ and remove the punchbowl when excess abounds. As such, Managers expect central bank balance sheets will continue to grow over time and provide a tailwind for equities, as there tends to be a strong positive correlation between equities and the Fed balance sheet.
Let’s examine the trajectory of total assets on the Federal Reserve’s balance sheet over the last two decades for example. As a consequence of the Great Financial Crisis of 2008, the Fed’s balance sheet doubled from $1 trillion to over $2 trillion (a small change by today’s standards). Their balance sheet continued to rise for much of the 2010s thanks to their continued Quantitative Easing programme, peaking at over $4.5 trillion mid-decade, before the Fed intervened again in 2018 to lower total balance sheet assets to just under $4 trillion. Then the covid crisis occurred and in response, the Fed’s balance sheet ballooned, more than doubling in size to almost $9 trillion in 2022.
Over the last twelve months, largely due to the recent inflation scare, ‘bad cop’ Fed Chair Jerome Powell has made a valiant attempt to curb financial market speculation and deliver price stability by sharply raising interest rates and selling central bank balance sheet assets. The consequences of his actions are now being felt as U.S. regional banks come under pressure.
In the last month, Powell has in fact been forced into an about-turn, boosting the Fed balance sheet by al- most $400 billion. An additional monetary stimulus may not be too far away, particularly if inflation continues to fall.
This is the environment in which we find ourselves today. It is not easy for an equity investor. Periods of volatility in both directions have become the norm. However, over time, Managers believe it should continue to pay to remain invested across a broad range of equity market sectors and regions, particularly if we are close to the end of the interest rate rising cycle, which is the general consensus view. Outside the United States, many regional markets have traded sideways for a very long time. European equities for example, have made very limited progress in over twenty years. The path forward will continue to be volatile but the direction for equities should be gradually higher over time.
