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17 Apr 2013
Forex Flash: Three misconceptions of short-term orientation of investors – JP Morgan
FXstreet.com (Barcelona) - JP Morgan analysts caution against the exclusively short-term orientation that many investors show, as even themselves have had to shift focus more to the medium term, “and this keeps us solidly overweight equities against fixed income, concentrated in the US and Japan”. The argument points to three misconceptions. First, that it is often argued that to de-risk a portfolio, one should hold more bonds, as they have much lower volatility than equities: “We contend this is true over the short term, but much less so over the long term, as much of equity volatility is noise that disappears over holding periods of 3 years and more”, wrote analyst Jan Loeys, adding that “bonds are nominal assets that move with inflation which is not a stationary process. Over periods of more than 10 years, we note that US equities do not show that much more volatility than Treasuries”. Also, risk should be seen as the probability that you fail your objectives. Having said that, “pension funds that are underfunded would maximize the chance that they fail their liabilities if they invest largely in low-yielding fixed income. With equities, they would at least have a fighting chance”.
Another misconception comes from central bank large-scale buying of debt (QE) which is seen as necessarily bad for its currency, but that is only correct in the short term view, as QE lowers the future return (IRR) on bonds. “The medium-term impact seems much less clear, though, and depends on whether QE creates inflation, or growth, or both. QE policies that are pursued by a central bank that has otherwise run out of tools, with an economy running well below capacity, but without fiscal expansion should boost growth prospects and confidence but not inflation”, which is bullish for the currency.
“A third misconception is that there is just too much debt in the world. Debt by itself is not “bad”, but an efficient way to marry the needs of investors and borrowers, one for lower-risk assets, and the other for lower-cost funding”, wrote Loeys, adding that the optimal amount of debt for a borrower depends on how volatile their earnings and asset values are. “A volatile world, country, or company requires less debt funding. But to the extent that policy makers have made the world economy more stable in recent years, one should expect issuers to rely more on funding. That would be a sign of confidence”, he continued, pointing also to the example of the Euro in regard to rapid deleveraging that ran into the paradox of thrift thus easily destabilize an economy.
Another misconception comes from central bank large-scale buying of debt (QE) which is seen as necessarily bad for its currency, but that is only correct in the short term view, as QE lowers the future return (IRR) on bonds. “The medium-term impact seems much less clear, though, and depends on whether QE creates inflation, or growth, or both. QE policies that are pursued by a central bank that has otherwise run out of tools, with an economy running well below capacity, but without fiscal expansion should boost growth prospects and confidence but not inflation”, which is bullish for the currency.
“A third misconception is that there is just too much debt in the world. Debt by itself is not “bad”, but an efficient way to marry the needs of investors and borrowers, one for lower-risk assets, and the other for lower-cost funding”, wrote Loeys, adding that the optimal amount of debt for a borrower depends on how volatile their earnings and asset values are. “A volatile world, country, or company requires less debt funding. But to the extent that policy makers have made the world economy more stable in recent years, one should expect issuers to rely more on funding. That would be a sign of confidence”, he continued, pointing also to the example of the Euro in regard to rapid deleveraging that ran into the paradox of thrift thus easily destabilize an economy.