The US Federal Reserve continued to taper its bond purchases during the third quarter of 2014, amid greater-than-anticipated improvement in the US labour market (and despite lingering concerns over stagnant wage growth). Meanwhile, Eurozone inflation slowed further. In response, the ECB has recently announced its intent to increase the size of its balance sheet by around €800bn through two mechanisms. First, it will provide ultra-cheap funding to banks to then on-lend to the private sector and, second, it will purchase private sector securities. As the latter will be financed by money creation, it essentially amounts to small-scale Quantitative Easing.
There has been a massive compression in risk premia across multiple asset classes over the last 18 months. Within equity markets, one manifestation of this has been the underperformance of lower-volatility, high-quality stocks. We consider this a warning sign and believe there is an elevated probability of the risk compression unwinding over the next year or so, as investors focus on normalising US interest rates. As such, we continue to consider the unwinding of Quantitative Easing as the single most important factor that will impact markets and economies over the next few years.
Furthermore, it remains possible that China’s economy could experience a significant slowdown as a combined result of market forces and the government’s continuing efforts to address the structural oversupply inherent within its housing market. The rapid rate of credit expansion experienced by China in recent years, and its role in funding fixed asset investment and property developers, adds further risk to the situation.
To listen in more detail from Magellan CEO, Hamish Douglas about his view of the world and how his fund is positioned, watch the video below.
This has been extracted from a recent publication from Magellan Financial Group.
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