Recent rounds of quantitative easing by the Bank of England and the European Central Bank’s long-term refinancing operations mean the case for a risk-on trade may be growing. With central banks maintaining their use of extraordinary monetary policy to avert recession or, worse, a deflationary spiral, the value of a cautious stance may continue to be eroded.
Over the year, equity markets performed relatively poorly, with the FTSE 100 falling by 2.18 per cent and the S&P 500 rising by just 1.47 per cent in dollar terms. In contrast, the average fund in the IMA UK gilt sector returned 16.04 per cent, according to FE Analytics.
The three-year picture tells a different story. Between March 6, 2009 and March 6 this year, the FTSE Small Cap index has comfortably outperformed the FTSE 100, returning 101.48 per cent to 81.77 per cent respectively.
Most of these gains were achieved between 2009 and 2010 but there are indications that the flight to safety that began last year may prove fleeting.
With the yield on 10-year gilts at 2.13 per cent and 10-year US Treasuries at 1.96 per cent, there is a growing debate as to how much further these assets can rally. They are already providing negative real returns relative to inflation.
Whitechurch Securities head of research and AFI panellist Ben Willis says: “Compared to our peers we have been slightly more risk-on. We were not in gilts last year, which hurt us a bit but we could not see the value in them.”
Giving evidence to the Treasury select committee in October, Bank of England deputy governor Charles Bean said the announcement of a further £75bn of quantitative easing should help support economic growth and push up inflation expectations.
The problem with Bean’s analysis is that the economic benefit from the first round of easing came predominantly from the so-called liquidity premia effect as the capital injected helped provide an alternative source of financing to otherwise frozen credit markets.
There may yet be a significant tailwind to risk assets not despite but, ironically, because of broader macroeconomic weakness. Central banks’ determination in providing support to a fledgling recovery could provide impetus in an otherwise low-return environment.
Willis, however, warns against trying to time markets. He says: “We have had a great start to the year but we are not going to make any knee-jerk reactions from here. Though we believe central bank policy will remain supportive, if you try to second guess the political or economic landscape it is seldom a sensible policy.”
The Bank’s quantitative easing programmes and possible further easing from the Federal Reserve might augur well for markets. Faced with a negative real return from safe havens, they might prove a gamble investors are willing to take.
Data supplied by FE