Recently, the main movements on the stock markets are the result of major central banks operations: from changes in monetary policies and interest rates to declarations and reports issued during and after meetings. This is how investors are at the mercy of the actions taken by central banks.
The policies of central banks have become the main economic news of this period. The markets no longer follow the trend of the economy but above all the central banks’ decisions.
The Bank of Japan (BOJ) has been the first bank to start this journey with the entry of interest rates in negative territory at the meeting of January, by cutting rates on bank deposits to -0.1%.
Then it was the turn of the European Central Bank (ECB) that lowered all rates, increasing the QE program of 20 billion Euros per month and including the investment-grade corporate bonds in the purchase of securities program.
The Federal Reserve and the Bank of England (BoE) did not take any decision, at least for the moment.
The intervention of central banks is the demonstration of a necessary support to an economy that struggle to grow, but it reinvigorate investor confidence and influence the markets. The volatility that affects the markets in recent years has been much more correlated with the tone used by the central banks.
Considering all this, investors have had to change again and again their strategies in order to not further endanger their portfolios. What investors can have from all these maneuvers?
When a central bank announces a quantitative easing policy, usually it happens the following situations on the markets: rising indices, bonds and government bonds linked to the central bank’s currency that has embarked on the QE; devaluation of the currency managed by the central bank making the QE.
In the latter case, investors can invest in shares and bonds thanks to the appreciation due to QE and also invest in other currencies for their potential appreciation against the currency subject to QE.
Vice versa for an investor outside the monetary area in which it is carried out the QE, he should consider the currency exchange risk because in the face of a possible rise of stock indexes in that area, it is very likely the depreciation of the currency and that would defeat the rise itself.
Negative interest rates involve real implications on investor portfolio, exacerbating the desperate search for yield in the bond market which has now been going on for some time. Before the great crisis of 2009, various bonds were offering 4-7% returns for investors worldwide. Today these opportunities are basically gone.
With the drop in interest rates, investors have had to choose between risk and profits. The current rates are forcing investors to significantly increase their investments or to significantly lower their profit expectations. Another option for investors is to adopt a more aggressive approach in the context of their bond investments. However, investors should understand that these would increase the risk of their portfolio, because these investments are more volatile and they have a higher correlation with stocks.
It is important that investors pay attention to not get carried away by central banks allocating their portfolio beyond their risk tolerance.