7 May 2018
Author: Vasu Menon, Senior Investment Strategist, Wealth Management Singapore, OCBC Bank, Member of OCBC Wealth Panel
I have been tracking and analysing markets for almost 30 years, but the past 10 years were the most unusual and difficult years for analysts like me as markets experienced a confluence of unprecedented events and uncertainties that effectively caused a big paradigm shift and heralded in a new normal for financial markets.
So much has happened in the past 10 years. Whoever thought that the US financial system would run into the kind of serious problems we saw in 2007/2008 which caused a serious global financial crisis? Whoever thought that Europe would run into a massive debt crisis that brought the region to its knees and almost caused “bankruptcy” among several European economies? Brexit and Trump’s victory were other black swan events which caused shockwaves. China’s unexpected devaluation of its currency in 2015 was another unthinkable event which caused a sell-off in global markets.
Despite all these major events – what’s amazing is that the past 10 years was also one of the most profitable periods for investors who had invested and stayed the course – global equities rose more than 200 per cent in the past 9 to 10 years while global bonds rose by more than 40 per cent.
How was this possible? We have the central banks to thank for – interest rates were slashed to record low levels and ultra-loose monetary policy saw billions of dollars in funds being injected into the global financial system. A lot of this money made its way into the financial markets and boosted prices. Some of it also made its way into the property markets and caused property prices to rise sharply as well.
But can this go on for the next 10 years? It seems unlikely. Global central banks have reversed course and are now raising rates and downsizing their balance sheets or they are signaling their intentions to do so. The process will probably be gradual as central banks know that they have to manage their exit strategy carefully so that all the good they have done in the past 10 years is not undone.
But one thing is clear – central banks are likely to tighten monetary policy in the next 2 to 3 years. This implies that the easy money has been made and the spectacular return that we saw in the past decade is unlikely to be repeated. In other words, past performance is not a good gauge of future returns. This reality may not have sunk into many investors yet. Many may think that the party will go on unabated.
These are the facts: the global economic expansion is at a mature stage and valuations for equities and bonds are no longer as cheap. This does not mean that economies and markets are poised to tank or investors won’t be able to make money and should hold cash instead. It just means that the loose monetary policy which helped to boost stock and bond prices is behind us, and the easy money has been made.
Going forward, investors have to moderate their expectations. It is critical at this stage to put in place strategies to manage downside risk when investing in markets. This includes ensuring that portfolios are well diversified across asset classes, markets and over time (i.e. dollar cost averaging). Often, investors focus on returns when putting money into markets and fail to pay adequate attention to risk. Risk management is probably more important at this juncture than it has been in the past 10 years. So go ahead and stay invested in markets but don’t throw caution to the wind.
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