The collapse of Bitcoin is a good example of what impact the withdrawal of liquidity by central banks could have on markets, according to Canada Life Investments’ David Marchant.
Marchant, chief investment officer at Canada Life, who also oversees all investment functions at the firm, said the process of monetary policy normalisation is likely to take a toll on markets and the economy in 2019.
“Next year, I think we’re looking at slowing growth, maybe – and it’s a bit of a hackneyed phrase – but synchronised global growth is increasingly less synchronised,” he explained.
“We had some acceleration of growth as a result of Donald Trump’s tax cuts – I’m not sure we really needed it – but they should wear off next year.
“Normally that would be okay for markets but what concerns me most is that we are going through this phase of unwinding the unconventional monetary policy that we’ve had for the last 10 years.”
Indeed, central banks have started to, or at least talked about, ending quantitative easing and raising interest rates, with the US Federal Reserve taking the most aggressive stance.
“Central banks need to get rates up to protect against the next recession and unwind the QE that we’ve seen,” Marchant said. “The side effect of QE has been that a lot of peripheral assets have gone up in value, and not just bonds and equities.
“You’ve seen a rush into high yield debt globally. You’ve seen it in the prices of sports cars have gone through the roof.”
Performance of Bitcoin over 1yr
Source: Bitcoin.com
As an example of how the withdrawal of liquidity could impact markets, Marchant highlighted the collapse of cryptocurrency Bitcoin, which has suffered as investors have become more risk-off.
“Cryptocurrency holds no value, it doesn’t fulfil the purpose of a currency and when you see tube station adverts to buy Bitcoin, it always tells you something,” he said.
Indeed, markets experienced a sharp sell-off in October – with weaker sentiment continuing into November – following comments by Fed chair Jerome Powell over faster-than-anticipated rate hikes.
Over three months the MSCI World index is down by 7.35 per cent, as the below chart shows.
Performance of index over 3mths
Source: FE Analytics
“Although I don’t want to say that I was calling for a pull-back, I did highlight some of the risks that are in markets: the hunt for yield, the hunt for growth assets, the excess liquidity pushing things up beyond what they should be valued at,” said Marchant.
“So, I think markets were especially vulnerable, but did I see it coming in October? Not particularly. It’s often difficult to pinpoint a particular event that will tip markets over but I think it’s an accumulation of slightly negative news and concerns about trade that people have largely ignored for much of the year.”
The chief investment officer said many investors had expected the so-called ‘trade war’ between US and China to blow over but it has dragged on longer than many, including Trump himself, expected.
However, he said that the number of headwinds facing markets was not particularly unusual, although they were disparate, encompassing everything from a fall in oil prices to concerns over the Italian economy.
“I don’t want to forecast the end of the world – we are still growing [and] if you look at valuations they are reasonable,” he said.
“We are cautious but not too cautious. Valuations are okay, the economy is growing enough to keep things bubbling along. But there is an element of risk in the actions central banks withdrawing liquidity from the market, it could destabilise things into next year.”
While interest rates are starting to rise, Marchant said investors’ hunt for yield that has characterised much of the post-crisis environment is likely to continue because of the ultra-low rates witnessed for much of the post-crisis period.
“Although rates will go up, I don’t see them going up a lot because inflation is still under reasonable control,” he explained. “But as rates go up and the yields in bond markets go up, it will pull people back from peripheral areas of the market.”
Given the backdrop, Marchant said investors need to ensure they are properly diversified to protect them against any fall-out from the process of ’quantitative tightening’ (QT).
The strategist said Canada Life Investments had added short-duration assets to its multi-asset funds and stayed away from higher risk areas such as high-yield debt and US technology stocks. It has also avoided emerging market exposure given concerns over liquidity in the market.
While the post-crisis stage of the market seems to be drawing to a close after a decade of ultra-low rates and QE, it remains to be seen how the next crisis will unfold, said Marchant.
“History suggests that we might learn the lesson of one crisis [and] make mistakes for the next,” he said. “So, my expectations for the next crisis when it comes will not be a banking crisis but will be in some other area where we’re not paying sufficient attention.
“We live in a world where markets ebb and flow and you do get areas of excess from time-to-time.”
He concluded: “The fact is that regulators, investors and banks are pretty well-placed to deal with an economic shock with the build-up of capital we’ve seen over 10 years.”
Marchant, who joined the firm in 2013, is co-manager of the risk-rated LF Canlife Portfolio range and fund-of-funds range along with head of multi-asset Craig Rippe.
Performance of funds over 3yrs
Source: FE Analytics
The mid-range, £175.7m LF Canlife Balanced fund-of-funds has delivered a total return of 20.73 per cent over three years compared with a 15.87 per cent gain for the £104m, five FE Crown-rated LF Canlife Portfolio IV fund, as the above chart shows.
The LF Canlife Balanced fund has an ongoing charges figure (OCF) of 1.02 per cent, while the LF Canlife Portfolio IV carries a charge of 0.81 per cent.