Will the central banks crush your investments?

The monetary policies of central banks could impact on your investments. What are your options?

investments downturn

“Its gonna be different this time”… Good old confirmation bias has a lot to answer for.

Confirmation bias is where we look at information that supports our views and reject the information as nonsense that doesn’t support it. And that is how financial bubbles, Brexits or Remains occur.

As F Scott Fitzgerald stated “The test of first-rate intelligence is the ability to hold two op­posed ideas in the mind at the same time and still retain the ability to function.”

Whilst financial noise is abundant, the financial adviser, keen to protect their customer’s assets against loss or inflation can easily be pulled into jumping in and out of the market. As we stated before, there is no bell rung at the top or bottom.

However, another keen quote (from Keynes) to assist with financial bubbles, Brexits or Remains, reportedly states that “when the facts change, I change my mind, what do you do sir”.

There are many current risks to the investment market that need attending to and we will cover them here to assist in the protection of your financial stability/freedom.

Unbeknown to many, central banks have been openly inflating equity markets with their monetary policies of quantitative easing (QE – banks simply type in that they have money and buy up financial assets to increase liquidity into economies) et al.

This ‘pumping up’ can only carry on for so long and at some point has to retreat. The key is whether or not a central bank can sell back the assets it has bought without collapsing global markets.

Most would be of the view (with just ten years passed since the global financial crisis) that central banks will have their eye firmly on matters rather than being caught as complacent again – remember Ben Bernanke saying that subprime mortgages would have a limited effect on the housing market and economy?

Central banks, however, have been clearly advertising their intention to unwind from their purchases (and so deflate) markets, which weakens the chance for a knee jerk collapse.

The artificial inflation of stockmarkets makes its way into your pensions and ISAs and as such affects your future spending power either way.

By all measures, equity markets are currently overvalued against historic measures, but of course that doesn’t necessarily mean they fall back to those historic levels.

It’s hard, however, to ignore some very obvious points and risks. If there was a crisis now, the central banks don’t have the ability to reduce interest rates or increase more QE as they have already done that.

Where is the safety net? Nobody knows.

Jim Rogers, the American investor, is very negative on markets, pointing to the Federal Reserve running a balance sheet five times that of pre the global financial crisis levels and with China having ballooning debt, as opposed to the huge rainy day fund it once had. His bearish words predict governments and countries failing. (1)

Soc Gen’s fund manager Albert Edwards believes a crash is inevitable and that central banks will lose their independence over it.

Other fund managers have begun to insure against a downside risk in markets falling and that the cost of insuring (by buying options that bet the market will fall) is rising rapidly. (2)

In March, 80% of investors in the US agreed it was overvalued and that it was trading on a valuation TWICE its long term average. The FTSE100 is trading at 30 times its price earnings ratio, and the UK as a whole at 21 times, but the long term average is 14 times. (3)

Indeed the Bank of England has written a paper on the matter (simulating stress across the financial system…) such is the concern that different component parts of the economy could amplify into a meltdown.

Given the extraordinary amount of cash moving into exchange traded funds, it is no surprise they have also concluded that liquidity management tools such as suspending redemptions (stopping people cashing in their money) needed investigating as an option.

Markets that are expensive can get more expensive, just as those that are cheap can get a whole lot cheaper. However, investors relying on guarantees and/or those retiring soon who cannot cope with a downward shock should pay attention to that.

Holding all data in your head to make good decisions is indeed a great skill.

For a complimentary initial chat on the above call 0800 0112825, or visit www.wwfp.net

Peter McGahan is the owner of Independent financial adviser Worldwide Financial Planning, which is authorised and regulated by the Financial Conduct Authority.

Last modified: June 10, 2021

Written by 11:12 am News & Views