First, some background:
Toward the end of 2008, to further stimulate the U.S. economy after the discount rate was lowered to near 0 percent, the Federal Reserve (the Fed) started buying debt in the open market, a policy known as Quantitative Easing (QE). Former Fed Chairman Ben Bernanke referred to this massive intervention as an economic “bazooka.” By the time the program ended in October 2014, the Fed had bought $4.5 trillion in bonds and a bull market in stocks ensued.
And not just the U.S., but major economies around the world are also in the midst of their own dramatic central bank policy shifts.
For example, as China braces for a slowdown after decades of heady growth, the People’s Bank of China is weighing its options. The yuan has been the strongest major currency in the world since 2000. If China is unable to soften its transition to lower growth by measures such as managing its banks’ lending, a devaluation of the yuan could be the way China stimulates its export economy.
The European Central Bank (ECB) president, Mario Draghi, promised to “do what it takes” to stimulate growth in Europe. So, beginning in March 2015, the ECB began its own massive trillion euro QE, continuing until at least September 2016.
And in Japan, “Abenomics,” a reference to Prime Minister Shinzō Abe’s extraordinary intervention policies, is still attempting to invigorate the economy.
While bazooka-style monetary policy interventions are all the rage to get economies on track, fiscal and structural reforms that could help reignite an economy have proven more vexing to implement. Why? Because while monetary policy is typically run by somewhat independent central banks, fiscal and structural management is run by governments whose political sensitivity can stymie progress.
For example, the U.S. needs infrastructure rebuilding, immigration reform, management of its national debt, election reform, tax reform and fiscal discipline on Medicare, Social Security and defense spending, but a politically contentious government seems incapable of progressing on any of those fronts.
As to the future, questions loom worldwide that could affect investor strategies. For example, in the U.S., will the Fed raise its discount rate or start reducing its balance sheet, and if so, will that result in U.S. stocks and bonds dropping due to higher interest rates? Will the Eurozone be the next place for a bull market in stocks as its economy responds to its interventions? Will China devalue the yuan to stimulate its economy? Can Japan get it right?
In light of all of these interventions and potential interventions, the real question is: What should investors do now?
They might be wise to reduce investment exposure to economies where central banks are slowing down, while at the same time putting some of their money in weakened economies as central banks launch bazooka-style interventions. But before they do, investors must also question to what extent those interventions have already been priced into the markets and, for that matter, whether they will be successful. And returning to policy versus politics, perhaps the ultimate question is:
Can economies such as that in the U.S. which have achieved liftoff continue to reward investors without fixing the problems that got them into trouble in the first place? As the saying goes, only time will tell.