Global Quantitative Tightening Gets Underway
If the year were to have ended last Friday, the broad U.S. stock and bond markets would both be down on the year, albeit slightly. Cash, in the form of three-month treasury bills, would be up, outperforming both stocks and bonds for the first time since 1994. Trade tensions, weakening global economic growth, and plunging oil prices are all potential drivers of weakness in risky assets. However, Ned Davis Research (NDR) offered another piece of the puzzle that they believe may be the driving force of this year’s investment difficulty – quantitative tightening.
As the chart below shows, in Q3 of 2016, interest rates (blue line, top clip) bottomed near the peak in global central bank asset purchases (red bars, bottom clip). They have moved steadily higher since. NDR projects that the global balance sheet is projected to contract this month for the first time in the cycle. Rising rates have been a key headwind for risk assets this year. Higher rates mean lower bond prices, a higher cost of capital for corporations, pressure on margins, lower intrinsic values, and increased competition among higher yielding assets. If less central bank demand is a primary cause for higher rates, the chart below suggests that the trend may continue, if the Bank of Japan, European Central Bank and U.S. Federal Reserve are not forced to change course.
NDR offered their version of a chart to capture the historic significance of this year’s broad weakness across various asset classes. Their definition of winners are asset classes that provided a 5% or greater return in a given year. The below chart puts into context how difficult it has been to find “winners” in 2018. NDR used benchmarks measuring large- and small-cap U.S. stocks, developed international stocks, emerging market stocks, long-term U.S. Treasurys, U.S. aggregate bonds, commodities and real estate. Thus far, there have been no asset classes that meet their definition of a winner, which would be the first time that has occurred since at least 1972.
2018 is coming off back-to-back years in 2016 and 2017 where 75% and 88% of assets, respectively, returned more than 5%. Not even one of the eight asset classes referenced had a negative total return in either 2016 or 2017. If global quantitative easing was a key force in driving asset classes higher, it makes sense that quantitative tightening may continue to provide a headwind across several asset classes, that is, unless central banks are forced to ease again.
As central banks allow their balance sheets to shrink, it’s possible that will create winners and losers, between and within asset classes. In that scenario, proper diversification is likely to add value in mitigating downside risks.
What Is News or Noise?
Like most of you, we are inundated with information on our phones, in our email inboxes and on the Internet. Clearly, the world doesn’t need another investing blog to reprocess stale information or reformat the day’s useless headlines. Thus, in our investment blog, News or Noise, we’ve taken up the challenge of sorting through the infinite bits of background noise and seeking the few truly newsworthy nuggets of information. What are the stories today that are likely to be meaningful for investors in the future? A very small number of headlines are important, and of those, many are immediately processed by investors. Only a tiny fraction of all the new data is truly relevant and underappreciated.