For the uncomfortable truth is that however much the finger is being pointed at the hapless Kwarteng and ‘it’s all his fault’, his was merely the straw which broke the camel’s back. For more than a decade-and-a-half, western economies have been in the grip of lazy, left-of-centre Keynesian economic groupthink. It has been too easy, too convenient to maintain the status quo. We have all been complicit in propagating and taking advantage of it: governments, central banks, investment banks and the financial community, companies, individuals as consumers, and investors.
‘Cold turkey’ on the withdrawal path was evident on several occasions as the Fed in particular tried to unwind QE, slowing the bond purchases with the intention eventually of stopping altogether. 2013 was the first adverse reaction, one of several which followed, dubbed ‘taper tantrums’. Bond investors saw the major supporting agency, the central bank, habitually buying bonds from them and helping keep bond prices rising, casting them adrift. The natural reaction? Get rid of your own bonds and book the profit before prices go down. Everyone else follows suit. Result? A collapsing market. How do we restore order (the prime function of a central bank is the maintenance of orderly markets)? Get the central bank to engage reverse gear and buy bonds again.
But it was the Bank of Japan (BoJ) and the European Central Bank (ECB) which began to use QE in a very different way, not as a financial prop but as an instrument of economic policy to try and stimulate inflation and economic growth too by accelerating QE to the point that the excess liquidity added to the money supply would trickle down to the real economy and the consumer. Everyone would benefit – in both jurisdictions, but particularly in Japan, there was determination that the strong deflationary pressures facing both economic regions were the real danger, leading to long-term economic decline; their brand of QE was designed at least to temper those forces. The BoJ extended QE to include not only government bonds but lower strata of fixed income, and eventually equities too. In 2015, the ECB started buying bonds issued by national eurozone governments, not equal in quantity to their issuance but in multiples of it; the inevitable result was a persistent rise in bond prices and a significant drop in bond yields to the point they became negative, consistent with the ECB’s negative deposit rate of -0.5%.
As is well documented, QE produced rising bond prices but caused other assets to correlate too, in particular equities and property, as investors (and in this equation, the ones that matter are the pension funds and the life companies) sought less expensive sources of cash income to meet their liabilities as bonds became increasingly poor value. Investors had no reason to see the end of QE if the result was the prop supporting markets being pulled away.
As inflation stayed mostly within the limits of the common target of 2% inflation shared by the principal central banks (the Fed, the Bank of England, the ECB and the BoJ), so there was little incentive to shift policy despite universal negative real rates of interest giving zero incentive for governments, companies and individuals to save cash and every incentive to borrow more.
Indeed, the fiscal policy landscape had changed considerably. A decade of anaemic growth and low productivity with falling real earnings was to be met with stimulus. Governments of all political persuasions would spend on a grand scale: infrastructure; welfare; the accelerating shift to carbon net-zero. Deficits were the norm, the need to reduce debt shelved. Fiscal stimulus aided and abetted by loose monetary policy is the breeding ground of inflationary pressures.
The one notable and honourable exception was Germany where post-GFC policy makes it illegal for the government to budget a deficit of anything but the smallest proportion.
And then the pandemic hit, followed swiftly this year by Putin’s invasion of Ukraine and what is in effect World War Three by proxy. The fiscal and monetary response, the sanctions regimes and Putin’s reactions and their inflationary effect are well documented and will not be repeated here. We have discussed them many times.
While the domestic media focus has inevitably been very much on the UK, leaving aside our Chancellor’s successful attempt casually to shoot himself in the foot, to a greater or lesser extent most western governments are all making heavy weather of dealing with the near-universal cost-of-living crisis. One government, Italy’s, has already fallen directly as a result. It is unlikely to be the last.
The UK has undoubtedly produced its own pratfalls but the essential truth of what confronts investors is that across the western world, previously complacent central banks are now going flat-out using monetary levers to try and contain inflation which ran away from them, while governments’ fiscal policies are still fully pedal to the floor spending money and increasing their national debts. They are pulling in opposite directions. That is the definition of irrational economics, something on which the IMF remains surprisingly mute (nor curiously did it feel necessary to wade in in July when the ECB had to announce emergency measures to prevent exploding Italian and Greek bond yields presenting a systemic risk to the eurozone, deploying tactics which are not only irrational and illiterate but quite possibly illegal; perhaps because Christine Lagarde the current head of the ECB was previously Managing Director of the IMF and her successor at the IMF, Kristalina Georgieva, is a former European Commissioner? Perish the thought!). The cost of funding that debt is rising not by percentage points but in multiples, and very quickly, and not just in the UK. It is a toxic brew, manifest in the extreme volatility seen in global bond prices, currencies and, so far to a lesser extent in equities.
The Jupiter Merlin Portfolios are long-term investments; they are certainly not immune from market volatility, but they are expected to be less volatile over time, commensurate with the risk tolerance of each. With liquidity uppermost in our mind, we seek to invest in funds run by experienced managers with a blend of styles but who share our core philosophy of trying to capture good performance in buoyant markets while minimising as far as possible the risk of losses in more challenging conditions.
The value of active minds – independent thinking
A key feature of Jupiter’s investment approach is that we eschew the adoption of a house view, instead preferring to allow our specialist fund managers to formulate their own opinions on their asset class. As a result, it should be noted that any views expressed – including on matters relating to environmental, social and governance considerations – are those of the author(s), and may differ from views held by other Jupiter investment professionals.
Fund specific risks
The NURS Key Investor Information Document, Supplementary Information Document and Scheme Particulars are available from Jupiter on request. The Jupiter Merlin Conservative Portfolio can invest more than 35% of its value in securities issued or guaranteed by an EEA state. The Jupiter Merlin Income, Jupiter Merlin Balanced and Jupiter Merlin Conservative Portfolios’ expenses are charged to capital, which can reduce the potential for capital growth.