The problem is, of course, that the longer central banks feed the monster, the riskier it is to continue riding it.
Hawksmoor Investment Management head of research, Jim Wood Smith agrees that the current situation cannot last, but argues it is not just the central banks that are at fault.
He points out: “If the economy is really so bad that zero gilt yields can be justified, then the outlook for dividends is terrible. And if that is true, I want some compensation for my risk. That in turn comes from getting some dividends, not pricing them at infinity.”
And, he adds, while most businesses seem to be fairly sanguine, despite the economists’ projections, those that do admit that life is tough are hard hit.
“The market is demanding earnings growth, but rejects the economic conditions to support this. It cannot last. It is massively unhealthy and central banks should stop pandering to it. They are like meadow pipits frantically feeding the monstrous cuckoo in their nest, terrifyingly ignorant of the inexorable course of events.”
Disjuncture
So where does this leave investors?
For Peter Toogood, the problem is likely to resolve itself in one of three ways.
Scenario one, is one on which nothing changes, despite all the exertions of both governments and central banks. In such a scenario, those assets that pay an income stay well bid, he argues.
In scenario two, economic growth does eventually reassert itself, but headline inflation remains limited.
“This would be a classic “beta” market, with most sectors participating,” he said, “with previously beloved “bond proxies” lagging.”
The third scenario is, arguably, the one Wood-Smith is expecting, which is one in which the real economy accelerates and bonds sell off, as inflation rises.
According to Toogood, in such a scenario, “Bond proxies will struggle, while the sectors benefiting from growth in the real economy fly.”
“This has been happening in various guises for the past nine months,” he points out, “with the market desperate to believe in a secular economic growth trend, despite constantly mixed data.
Which brings us back full circle to the stubborn preference for deflation assets and the disjuncture between what generally drives bull and bear markets and how investors are actually positioned, which is for the continuation of low growth and even lower interest rates.
This tension has loomed over markets for a number of years now, but at some point it will need to come to a head, the question investors need to ask is what shape they believe that head is going to take.
