Portfolio effects of changing monetary policy

A decade after the financial crisis, one result of governments’ unprecedented stimulus programs is the buildup of debt across the globe, says Peter Hardy, vice-president and client portfolio manager at American Century Investments.

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Following the 2008 bankruptcy of Lehman Brothers, various central banks lowered interest rates and pumped money into the economy to combat the crisis.

Since 2007, global worldwide debt has increased from around US$142 trillion to over $240 trillion, Hardy said in a late-August interview. “This buildup of debt will lead to volatility and to potential reduced returns in assets.”

Another consequence will be slower economic growth, as people’s money is used to pay off mounting debt rather than for investments, he said.

Further, investors could see lower returns. “Part of the good returns we’ve seen in stocks and bonds, and real estate, has been by virtue of central bank policy,” he said, with the Fed, the European Central Bank and the Bank of Japan increasing their balance sheets from roughly US$3 trillion to US$15 trillion through their asset purchases.

“These purchases are a wall of liquidity that puts a bid on assets, and as that liquidity goes away you’ll see asset price returns revert to a lower level.”

Last week, for example, the ECB confirmed that it would cut the size of its monthly bond purchases in half after September. Those purchases will be reduced to 15 billion euros from 30 billion euros before they stop altogether at the end of the year.

The ECB isn’t expected to start raising rates until the second half of 2019, but the U.S. Federal Reserve hiked three times last year and twice so far in 2018, with two more expected before year-end.

The “wall of liquidity” from central banks has impacted another element of investing, said Hardy, whose firm manages the Renaissance U.S. Equity Income Fund. Aggressive monetary policy and asset purchases have contributed to historically low volatility.

“As this accommodative policy discontinues, you’re likely to see a higher level of volatility,” he said.

So how can investors prepare as accommodative policy retreats?

“Investors need to account for this by maintaining a diversified portfolio of assets,” Hardy said. Also, where investors have seen good appreciation in certain asset classes, taking some money off the table and returning to a target asset allocation may make sense, he added.

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