USA TODAY International Edition
CONFUSION IS NAME OF GAME ON WALL STREET
Unknown market influences wreak havoc with investors
In a world of negative interest rates and unprecedented market intervention by central bankers, Wall Street is morphing into a land of confusion, a place where timetested investment principles may no longer apply and risks are difficult to quantify.
Investors are grappling with market influences they never have witnessed before, which makes it that much more difficult to accurately price assets.
Exhibit One is negative interest rates, or central bankers in places such as Europe and Japan charging depositors to park cash in a bank, not the other way around, as a way to boost economic growth.
Exhibit Two is quantitative easing ( QE), or central banks going into the open market and buying up assets, such as government bonds, corporate debt and even stocks via exchange- traded funds, in an effort to keep interest rates low and inject liquidity into the system.
For Exhibit Three add in more modern risks, like “high- frequency trading,” where thousands of stock trades are executed in microseconds by computers, not traders; unpredictable and tough to explain “flash crashes,” where stocks go haywire due to computer malfunctions; and single- direction herd mentality trading now known as “risk- on” or “risk- off.”
Financial markets, Wall Street pros say, just don’t make much sense anymore. “I have asked myself many times if the markets have completely lost all reason or logic,” says Dwayne Adams, president of Adams Wealth Management Group.
Much of the confusion stems from post- financial crisis interference from central bankers such as U. S. Federal Reserve Chair Janet Yellen, European Central Bank ( ECB) president Mario Draghi and Bank of Japan ( BoJ) governor Haruhiko Kuroda. The record- low interest rates and trillions they’ve pumped into the global financial system have artificially driven up the values of assets ranging from U. S. government bonds to stocks.
“Right now, confusion reigns as central bankers continue to twist and turn with the wind,” Gary Kaltbaum, president of Kaltbaum Capital Management, says via email. “And, yes, they ( the central banks) are running the markets right now.”
Markets are far more unpredictable and difficult to handicap. The reason: Many of today’s major market drivers — such as QE, interest rates below 0% and computer- driven trading — are new developments. As a result, there are few historical examples of
how markets might react in response to these new inputs or how different markets might react to each other.
The fact the Fed is moving to boost borrowing costs at the same time Japan and Europe are in easing mode creates another unknown.
“This is an unusual paradigm for asset pricing,” says David Kotok, chief investment officer at Cumberland Advisors.
Helping to confuse investors: Negative interest rates. “If I had to identify a condition that intuitively makes less than complete sense it would be the proliferation of negative interest rates in many parts of the developed world,” says David Joy, chief market strategist at Ameriprise Financial.
The ECB’s main deposit rate is now minus 0.4%. That means depositors have to pay the ECB nearly half of a percentage point to park cash at the eurozone central bank. The BoJ’s rate is minus 0.1%.
What worries Joy is the message a negative rate strategy has on investors’ psyche and the po- tential unintended consequences of such a policy.
Fed’s lack of ammo. The Fed has already wound down its asset purchase program and is now starting to normalize rates. However, the Fed’s current shortterm rate of roughly 0.5% provides little firepower to combat future economic crises, says Bruce Bittles, chief investment strategist at R. W. Baird.
“The risk is with rates near zero the Fed is not in a position to come to the aid of a recession,” Bittles warns. “In that regard, this is one of the most risky markets, perhaps more risky than 2008.”
The Fed has kept rates near zero for so long, Bittles adds, that investors might have too much cash rising on a stock market that now is trading at above- average valuations relative to history.
“Many investors have been forced into stocks,” Bittles says. “Many don’t belong there or have too much allocated to stocks. As a result, there is the risk of panictype selling at some point. Stock market reaction to rising rates. “I agree the market feels weird, but that’s because our markets are trading on the opium of low rates,” says Michael Farr, president of money- management firm Farr Miller & Washington. “As long as rates stay low, I think the limbo dance continues.”
What worries Farr and other Wall Street pros is if the Fed raises rates sooner and more aggressively than market participants are currently forecasting.