It is currently an interesting time to invest and although it might feel as if the most difficult period is behind us, it wouldn’t be surprising if the global equity indexes continue to be volatile. As each day brings another shock to the financial system, investors may rightly question whether there’s an end in sight to the market turmoil.
Why Did This Happen To the Markets In The First Place?
The word ‘chaotic’ to describe this market should be used judiciously. This market is not chaotic at all. Conversely, completely ignoring the impending debt crisis seemed rather chaotic. As Invesco predicted, the moment would come when mounting debt levels would erode current consumption. That time is now. Easy access to capital, on relatively favourable terms, coupled with an insatiable desire to consume created the perfect storm.
In fact, the level of debt, leverage, and deficits has been rising steadily since the turn of the century. Simply put, households, corporations and governments overextended themselves and incurred debt levels so high that the cost of servicing that debt began to deteriorate the amount of disposable income that would have been left over to consume other goods and services. As a result, global demand is slowing down, and slowing down quickly.
This is not news. Hedge funds, asset managers and corporations have all been attempting to deleverage over the past year. Furthermore, residential real estate values in the United States have been dropping for nine months, literally delivering at least some recognition of the problem right to the doorsteps of households almost everywhere.
What triggered this realization of how problematic the debt crisis can be or ‘group think’ to sell is still up for debate. Let’s leave that issue aside for the theorists and focus on the vicious cycle the markets are in now. Defaults on loans are rising, causing banks to reduce their lending. The lack of lending is weakening the economy as profitable projects remain unfunded. The weakening economy leads to further defaults…and so it continues.
Evolutionary Actions Creating a Revolutionary Change
Rather than putting the finest minds together to devise a top-down macro solution, market participants opted to identify one issue at a time, craft a solution (or at least a potential solution) to that problem and implement that solution just in time for the next crisis to take hold. In retrospect, perhaps there would have been a less dramatic market dislocation if there was a ‘Bretton Woods’ opportunity to address this issue. However, no entity was willing—or some might even argue capable—to arrange such a meeting of the minds.
Investment Opportunities in This New (And Improved?) Environment
Every regime shift creates winners, losers and new opportunities for forward looking investors. Suffice it to say you already know if you won or lost, so now is either the time to cut your losses and realign your portfolio or count yourself lucky and reallocate with a fresh view. The market environment that you made your last portfolio asset allocation decision based on simply doesn’t exist anymore. In this new environment there are opportunities for investments outside the regular asset classes.
Don’t Fall Victim Again
In spite of the global coordinated effort to inject the economy with liquidity, clearly the bears have been rewarded. Large investors with long investment horizons should use this occasion to re-allocate their portfolios into investment strategies that make sense in the new regime. In addition to being rewarded for providing liquidity in this environment, eventually all of this liquidity will begin to have an impact on the economy. Waiting for that moment to begin reallocating assets could prove to be as costly as not protecting your portfolio when you first realized the crisis was about to take hold.
Diane Garnick is an investment strategist with Invesco Distribution US, an affiliate of Invesco Trimark.