Markets: Risky business

The Federal Reserve’s decision to wait before trimming stimulus has encouraged investors to pile back into equities, but caution would be a better bet.

Investors across the globe have lapped up Ben Bernanke’s permission to take risk.

The volume of shares traded on the ASX on Thursday was up an alarming 65 percent compared with the average daily volume over the past 30 days. Investors on the Euro Stoxx index were even more enthusiastic, with a 77 per cent surge in volume of shares traded overnight.

Legendary investor Warren Buffett says it best: “Be fearful when others are greedy. Be greedy when others are fearful”.

Bernanke has given the green light for risk taking by continuing with quantitative easing in its current form and investors aren’t holding back. Evidently, the continuation of the stimulus is perceived to be a positive for equity markets and the economy. Unfortunately, it may not realistically reflect the truth.

Recent economic data, which was improving, propelled US indexes to their all-time highs. But when the Federal Reserve came out and ultimately said the data to-date was not enough to begin winding back the current bond buying program, markets everywhere climbed higher.

Good data sends markets higher. But in the eyes of the Federal Reserve, the data isn’t good enough. So now we have a case of bad news sending markets higher as investors stuff their pockets with shares in fear they will miss out.

Yes, it is confusing. It should also sound as a warning for investors to begin thinking about the repercussions when the Federal Reserve actually commits to reducing the monetary stimulus from current levels.

Although tapering is not on the radar of the Federal Reserve for now, don’t think it will never happen. It will. Guidance from central banks is becoming increasingly important to manage economies so we can expect a clear and exact schedule when the time is near.

For now, interest-rate sensitive sectors, like property trusts and insurers, remain in the grips of the Federal Reserve. As long as long-term interest rates are intentionally the subject of manipulation, investors can use this information to position their portfolio accordingly.

Lower long-term yields are favourable to property trusts, allowing them to earn a bigger spread between their cost of debt and rent charges. When Treasury yields dropped in April, it sent the ASX 200 Real Estate Infrastructure Trust (REIT) index to yearly highs. Since then, the index (yellow line) has dropped as yields (white line) have risen.

Graph for Markets: Risky business

Source: Bloomberg

Insurers, as with any other financial, would prefer higher interest rates to help them earn a better margin. QBE can attest to this. For the most part, high Treasury yields equate to a higher share price for QBE. 

Graph for Markets: Risky business

Long-term interest rates will rise again and would be expected to hold at higher levels once tapering does actually begin. Looking for an investment partial to higher interest rates and low on popularity at the moment could be worthy of some attention.

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