The Great Unwind

The Great Unwind

Central Banks are winding back their asset purchases that have been in place as a response to the Global Financial Crisis in 2008, and are now going in reverse. That is, the buyers of last resort are stepping away and the once rising tide supporting all asset prices is going out. This is leading to increased volatility in the share market, rising bond yields (falling bond prices) and falling share prices. We think it is prudent for investors to consider lifting their defensive positions at asset class, sector and individual company level in order to maintain capital preservation.

Volatility: Expect higher volatility

The US Federal Reserve balance sheet has expanded steadily since 2009, as it attempted to revive the global economy and pump much needed liquidity into financial markets. This has had the effect of dampening volatility and increasing asset prices.

The last 12 months we have seen US Federal Reserve stop its asset purchase program which has meant that as bonds mature it is not conducting further bond purchases. This has had various impacts including greater volatility in equity markets.

Bond Prices: Expect lower bond prices

When the largest buyers start to unwind their asset purchase programs asset prices will inevitably struggle to move higher, including both Bonds and Equities. Investors that have moved up the risk curve will reverse course.

Equity Valuations: Expect lower valuations

Equity Valuations have seen significant increases since the lows in 2008 and have been boosted by broad based risk seeking behaviour that has been stimulated by central bank asset purchases. Investors have essentially decided that valuations aren’t that important, and don’t want to miss out on making money. This is typical behaviour during bull markets and ultimately sows the seeds for the cleansing stage that follows. There has been a downward step change in valuations at the start of 2018 which coincided with the beginning of the US Federal Reserve Balance Sheet unwind. As the unwind continues we would reasonably expect valuations to compress further.

By Daniel Rolley CFA