Catella’s Mats Andersson sees a ‘doped-up market
With the local stock market up some 23% so far in 2013, Mats Andersson, chief executive of Swedish manager Catella, has sounded a note of caution about the market’s reliance on easy money from quantitative easing measures.
I have previously written about the “search for yield” in an environment where “cheap” money is flowing into the global financial markets. Earlier this autumn we saw evidence that the market is dependent on cheap money when the US Fed began to whisper about “tapering” or, in other words, the start of a gradual reduction of its bond purchases. The reaction of the market was rising long-term interest rates and stock market jitters.
The purpose of the easy monetary policy from the world’s central banks is to heal and create a recovery in the global economy after the financial crash of 2008/09. The economies are slowly healing, but underlying growth rates are not convincing yet. However, many asset prices have rebounded sharply in recent years.
Could it be that all this cheap money is becoming addictive to the market? Or, in other words, is it that when the availability of this cheap money starts to decrease the stock market will fall and interest rates will rise sharply? Long-term doping can cause side effects. Is it the case that the market is doped-up by the extremely loose monetary policy, and what side effects could this have?
Somewhat simplistically, we can use physics to illustrate the forces on the financial markets. If you build a tall tower on small or weak foundations you are taking a risk. If the foundation starts to shake the tower begins to sway and, in the worst case, it topples.
For several years, the world experienced a dramatic expansion of credit that ended in the Lehman crash. A tower of credit grew to enormous heights on small and weak foundations. When it began to shake, we initially saw the top swaying (volatility) before the tower finally toppled – and the crash came.
One relevant question is whether the financial towers around the world have started to grow too tall again. This is due to an easy supply of cheap money that more often goes to investments in areas such as financial markets and real estate, instead of to investment in growth that should form the foundation. We saw very recently in the news that gearing on the US stock market is at a record high. Is it the case that the real economy this is resting on is healthy and growing sufficiently? In other words, is the foundation solid enough to bear the “financial towers” going forward? It is important to emphasise that a lot has happened since the financial crisis of 2008. For example, capital requirements for banks have been raised, regulations on risk-taking have been strengthened, and there is substantially more oversight from regulators of the risks taken by financial institutions. I certainly do not believe that the towers will topple going forward, but they may begin to sway a little more.
Volatility is now extremely low by historical standards (see chart). We still have extremely low bond yields and the values of many assets require very favourable future prospects, and with this in mind it would not be surprising if volatility increased.
As mentioned, we did see signs of this earlier this autumn, but when the Fed announced that the easy monetary policy would continue for a while the market stabilised again.
I have asked a number of open questions and there are no simple or obvious answers. However, it is important to be aware of the risks and challenges of the market. This is clearly reflected in Catella’s management organisation. It is not at all the case that we sit around worrying about taking risk, but on the other hand we have very good risk analysis and risk control. This is essential to enable the long-term delivery of a high risk-adjusted yield for our unit holders.