There was a time, before the Global Financial Crisis, when the job of the central banker was relatively straightforward.
The main objective was simply to control inflation and, as long as that sat around the 2% to 4% level, by and large, everyone was happy. Interest rates around 4% were tolerable. Indeed, by the time the Federal Reserve officially adopted its inflation target in early 2012, even 2% inflation was considered a bit racy. Of course, by that time, in the wake of the GFC, US interest rates were 0.25%.
This was part of the Federal Reserve’s efforts to support the economic recovery from the Great Recession and to help stimulate economic growth. Now, the job was controlling inflation and growing the economy. The mission creep didn’t stop there. With the luxury of stubbornly low inflation, something that was considered problematic at the time, the Federal Reserve maintained a regular commentary on the levels of borrowing, the housing market and job creation.
UK and eurozone central banks were also aligned with low-interest rates and similar inflation targets. It wasn’t all plain sailing, of course. There was the small matter of the Greek eurozone debt crisis to navigate and assorted shocks, economic and geopolitical, which rattled markets.
But the point to make is that, whenever push came to shove, with markets staring into an abyss, the Federal Reserve has always capitulated and eased monetary policy.
Yet it is also important to remember that these various crises almost always came at the end of a Federal Reserve tightening cycle, that is to say, a period of rising interest rates that caused something to go bang in the first place: Latin American debt in the 80s, the 1987 stock market crash, Asia ’98, 2000 tech crash, 9/11 etc. . .
The latest Fed tightening cycle, which began in March 2022, was surprising in both size and speed. The need to stem double-digit inflation was widely understood, but the hike from the post-pandemic rate of 0.25% to 4.75% in 11 months was always going to cause trouble. With the other central banks generally compelled to follow suit, that trouble was unlikely to be limited to the USA.
And so it has come to pass that the sudden failure of Silicon Valley Bank, followed by New York-based Signature Bank, has seen banking shares fall precipitously around the world. Exactly how Credit Suisse suffered a humiliating collapse in such a short space of time will be discussed for years, although its various difficulties and failures over the years have been well documented. Nonetheless, as one of the top thirty systemically important banks, its fall is alarming, raising as it does memories of the fall of Bear Stearns and Lehman Brothers in 2008.
It is exactly in this environment, characterised by large swings in stocks and bonds, where trying to time entry or exit from markets can go horribly wrong.
A good example is Credit Suisse’s Swiss rival, UBS, which acquired Credit Suisse over the weekend, supported with a raft of eye-watering financial backstops and guarantees from the Swiss government and central bank. While markets digested the news, shares in UBS fell sharply by 15% as the stock market opened on Monday morning. By lunchtime, they were up 1%.
How many investors, having panic-sold first thing in the morning, would now have the courage to re-invest at a level higher than if they had done nothing?
A longer-term investor might also be wondering whether it might be prudent to sell out of the UK’s FTSE100 index, heavily laden as it is with banks and financials which sold off last week, and park the money in the bank for a while.
However, the UK index has already fallen from its peak of 8,000 in late February to around 7,400, although this is pretty much where the market was for most of the summer last year. Unless you really think dividend cuts are coming across the market, walking away from a yield of 4.4%, both current and forecast, for the safety of 4% on deposit, isn’t immediately attractive.
The truth is that the long-term historical return on equities is far higher than cash on deposit. Investors who try to time the market by investing and liquidating portfolios based on short-term fluctuations are unlikely to outperform those who remain invested over the long term. In fact, missing even a few of the market’s best-performing days can significantly reduce an investor’s overall returns.
One commonly cited study by J.P. Morgan Asset Management found that between 1st January 1999 and 31st December 2018, an investor who remained fully invested in the S&P 500 index would have earned an average annual return of 5.6%. However, if that investor missed just the 10 best-performing days during that period, just 10 days out of a decade, their average annual return would have dropped to just 2.0%.
When markets are going through a period of volatility, the dips can provide an excellent portfolio entry point – especially for gradual investment – and opportunities for risk-controlled tactical gains. But liquidating entire portfolios with a view to re-investing at a lower level can go horribly wrong.
As always, the team at Fern Wealth are happy to answer any questions you may have.