The threat of a 1994-style crash in both equities and bonds is a genuine threat to investors, according to the team behind the Ruffer Investment Company. FE Alpha Manager Steve Russell (pictured) and Hamish Baillie say the economic conditions are similar to those in the lead up to severe multi-market correct almost 20 years ago, which saw the UK equity and government bond market fall by about 15 per cent a-piece.
“It is one of the paradoxes that we all need reminding of that any improvement in economic news is likely to mean greater volatility and possibly downright declines in financial assets as investors extrapolate to a period of reduced stimulus from central banks,” the pair said in a recent note to investors.
“The possibility of a ‘1994 moment,’ where investors lost money simultaneously in both equities and bonds as interest rates rose in response to a brightening economic picture, is, to that extent, a very real concern.”
Performance of indices 1993-1995
Source: FE Analytics
Russell and Baillie believe the recent pull back in both equities and bonds are due to concerns that Ben Bernanke could be on the verge of ending quantitative easing in the US.
“It seems gentlemen no longer prefer bonds, to judge by last month’s events as bond markets suffered their fourth worst month in the last twenty years and yields rose in every major jurisdiction, with the plucky exceptions of Portugal and Slovakia,” they said.
Performance of indices in May 2012
Source: FE Analytics
“Explanations given for such moves have been many and varied, but while hopes for better economic growth, especially in the US, might be part of them, a ‘will they won’t they?’ debate around the US Federal Reserve possibly tapering its asset purchase programme certainly played its part.”
Equities have also suffered significant losses in recent weeks, with the Japanese market leading the correction.
Hargreaves Landsown’s Adrian Lowcock believes that the removal of quantitative easing is one of the biggest issues facing investors, but says the prospect of this has both its pros and cons.
He points to the fact that equity markets reacted well to a rise in interest rates in the aftermath of the initial correction back in 1994 as evidence of this.
“If the US does start cutting back on quantitative easing it means the Fed is confident that the economy can grow sustainably, which overall needs to be looked upon as a good thing,” he said.
“Of course it’s all about timing. I’d be very surprised if it happens this year, and when it does happen it’s not going to be an immediate thing. It’s going to be more gradual than that.”
He says the recent pull back in markets was inevitable even before rumours that QE was coming to an end, and as a result doesn’t think too much should be made of it.
“When the markets were at 6,200/6,300 everyone was forecasting a correction. All that we’ve seen in recent weeks is April and May’s surge get cancelled out. To look at it as anything else is very short-term.”