The ground is shaking, but whether an earthquake is imminent is not clear. Both February and October have seen shock falls in share prices, while October saw sharp reverses in bond prices, too.
This is simply against the run of things – normally, bond prices rise when equities fall. The reason is simple: bonds are backed by governments and their risk is only that of interest rates, while equities must deal with risks to both their income and capital.
Changing regimes?
Since the banking crash in 2008, markets and economies have been buoyed by the flood of easy money, yet now there are ominous signs. Central banks in the US, Europe and Asia are cutting back on easy money policies, while highly leveraged commercial bond funds are still being bought as if no commercial risks exist.
Investors may believe that quantitative easing is still the preferred policy of central bankers, for economic growth is slowing around the world. But is the current risk more deflation, or instead a possible return to inflation? And how will trade wars and populist policies affect these trends?
Nothing goes up for ever, and Wall Street is approaching the end of one of its longest ever bull runs. In earlier years, this would be a signal to shift from equities to bonds. But no longer; now that central banks are players in stock markets, bonds have become as volatile as shares. What used to be known as the US Federal Reserve model of the 60:40 portfolio – split between equities and bonds – no longer works.
New opportunities
If government bonds can no longer be trusted, other methods of government financing can be. Opposition politicians may well complain of the cost of private finance initiatives, but once in office they appreciate the benefits of ‘stealth’ taxes.
Financing what used to be central government functions such as care homes, student accommodation, pipelines, fibre-optic networks and even roads and other infrastructure through private investment is more expensive, but avoids annoying voters by increasing taxes to pay for greater issuance of government bonds.
An unexpected advantage of this financing shift has been that stock markets have become central to banking stability. This was becoming apparent towards the end of the technology, media, telecoms boom at the end of the 1990s, then became accepted policy during the next financial crisis in 2008. And if equity markets are now central to banking security, governments must now stand behind them when they are faced with Minsky moments – the time when investors understand that financiers have moved from prudence to excess, and they themselves panic.
Investment professionals have moved on from a simple bond/equity split and private investors should do the same. This means identifying those investments that are not correlated to either equities or bonds, and instead offer alternative ways of buying income or capital growth.
Closed-ended opportunity
The best source for information on alternative investments is Numis Investments, although this month the Association of Investment Companies itself produced a full report on property opportunities.
