Recent major price declines, with US stocks entering a bear market and extreme falls on the more speculative side which includes cryptocurrencies, are a salutary lesson and a reminder that ultimately it is up to the investor individual to build a “safety net” for their portfolios and not the central banks. Indeed, soaring inflation is also pushing policymakers to raise interest rates at a faster pace than expected.
In general, we are now in reverse and those who listen to the noises of the markets will hear the “sucking noise” when liquidity is withdrawn. Unlike before, where bad news was seen as good news because it triggered more quantitative easing or rate cuts – now bad news is just that, bad news. We are in difficult markets with a very accommodative monetary policy and low interest rates now largely behind us. Intervention remains a factor in emergencies, as we have seen with the Bank of England and the £65billion bond purchase program to stabilize what was effectively a bond market of state broken and the pound in free fall. This leads me nicely to the subject of policy failure and inflation.
Managing and controlling inflation are central concerns for central banks. This is difficult and sets the stage for one of my main concerns – policy failure, including mishandling the interest rate/inflation conundrum and damaging economies, consumers and financial markets. Take the UK – the last time we saw this kind of inflation was in the 1970s, which means today’s policymakers are in new ground and struggling to navigate the situation. The actions of policymakers in this environment are of the utmost importance, as is the confidence of markets in them. Both of these areas are currently under scrutiny.
In reviewing the past two years, I have found that the topic of moral hazard, basis risk management, downside protection, or profitability when markets fall has been largely ignored. These are considered esoteric topics for hedge funds and some institutional investors or just don’t think about at all, and the underlying strategy is to buy the dip.
To add to this, wealth managers in general have not sufficiently prepared their retail clients for these very difficult markets. This is a missed and increasingly costly opportunity as retail investors scrutinize the performance of their portfolios. Perhaps the market shocks we are seeing now will encourage retail investors to explore this more deeply with a focus on diversification, active risk management, low leverage and a better understanding of all the inner workings of an investment portfolio.
I would encourage retail investors to be demanding of their wealth manager and to ensure that they have access to the “different cogs” of a portfolio at a fair price. Ignore the rhetoric that the risk management process is too complex – it isn’t, especially if it’s well executed and presented.
This message also applies to overweight investors in the UK. As we have seen, it is not difficult to paint a difficult picture for the UK – policy failure, high inflation, cost of living crisis, tight consumption, including mortgage debt in the face of rises interest rates, a heavily indebted government, the interest rate/inflation conundrum and the high volatility of financial instruments.
Therefore, the lesson should be not to rely on central banks to bail out the markets. We are going through a period of sustained market volatility and how investors manage this “risk” will be key to the performance of their portfolios.
Charles White Thomson, CEO of Saxo Markets UK