Anyone with an ear tuned to global financial markets will know that central banks around the world are winding up their decade-long programme of quantitative easing. Although originally designed to support banks suffering a credit crunch following the 2008 financial crisis, these have ballooned and extended over the last ten years and with interest rates at near zero for much of that time, prices of most investment assets have shot through the roof to ridiculous levels.
What is Quantitative Easing?
At its core, Quantitative Easing (QE) has involves a central bank buying enormous quantities of medium and long-term debt. The bank in question holds the assets (bonds) on its balance sheet, and cash is pumped into the economy. The abundance of cash then encourages market participants to spend and invest, lowering interest rates and stimulating demand. If an economy is going through a demand slump, this theoretically helps to counteract the decline in demand and return the economy to growth.
What effect has it had?
In practical terms, this explosion of capital has created a corresponding explosion of debt as money is cheap. This cheap money has flooded into the market creating unbelievable demand for equities, commodities, property and other assets. As a result, yields have collapsed, investing standards have declined and there are huge numbers of ‘investors’ that are acting more akin to speculators.
Stock markets have hit an all-time high, but I question whether this ‘growth’ is real or sustainable. After many years of pumping cheap cash into the market, central banks are now reversing their policies, reducing the levels are which they are buying new bonds, and selling off existing ones.
As central banks have gradually increased interest rates, markets around the world have suddenly entered freefall, with extreme volatility spikes that most investors have absolutely no prior experience of. Several of my own holdings, which have traded within an incredibly narrow band for over two years have suddenly started become extremely volatile – up 10% one day, then collapsing 5% the next, with no news or indication of why.
What will happen next?
With some banks not even reducing their balance sheets yet, but simply reducing their acquisition of new bonds, I have a feeling that market volatility is likely to continue for many years to come, with the likelihood being that many asset prices will collapse as speculators panic and sell off their holdings.
I don’t have a crystal ball, but speaking to investors, so many are spouting ‘common sense’ advice that I can barely believe it.
“Property will always go up”
“Shares will always go up”
“Amazon, Google and Netflix are the future”
“Tesla is the best company ever”
Ten years ago, these idiots wouldn’t have had the cash to throw around that they do now. You wouldn’t have property buyers willing to hold properties at a loss, or investors willing to pay 150x forecast earnings for a share. If you had to pay 8, 9 or 10% on your mortgage, you’d niggle over every last penny to get the price as low as humanly possible. You wouldn’t take out a £700,000 mortgage to buy a property yielding 3% before costs, because you’d lose £100,000 in interest and deal costs before you even considered void periods and wear and tear.
But when you only have to pay 1 or 2%, why not give it a punt? Everyone else is ‘investing’ right? Why bother doing the hard work to learn about how to do it properly?
The problem with this, of course, is that eventually the party ends. All that free money dries up, interest rates rise and all of a sudden those speculators are left with loss-making liabilities that they’ll do anything to off-load. But this isn’t just theoretical, this is people’s cash. All of a sudden, pension values collapse, people stop spending cash in the shops because their ‘investments’ are suddenly sold with huge losses, people that ‘felt’ wealthy suddenly feel poor, and as a result of all this, companies start pulling back on investment and employment, exacerbating the spiral.
So what do I think will happen? An almighty mess is what! Well, an almighty mess for anyone that hasn’t done their research, taken responsibilities for their money, and is then panicking because they’ve suddenly realised that their ‘assets’ were bought at stupid prices and are now losing them money. The rest of us will have to tighten our belts like we always do, but the coming downturn is going to be excruciating for anyone that thought investing was as simple as buying an \’asset\’ and waiting for it to go up.