FTSE Feels Normalization Headwinds

In general, accommodative monetary policy measures and quantitative easing programs are largely intended to re-inflate asset bubbles and channel investment funds towards risk assets in an effort improve lending and stoke inflation. A look at the strategies undertaken by global central banks in the wake of the 2008-2009 financial crisis puts these tactics on display. The real benefactor was not necessarily the real underlying economy, but often the financial economy which benefited from every expansion of Central Bank balance sheets. Now that the music is coming to an end in some advanced economies, the momentum higher in equities witnessed over the last few years is seeing optimism wane and valuations come under pressure. In the United Kingdom in particular, valuations are set to fall as investors begin to re-position portfolios to account for potential interest rates liftoff from the Bank of England. As a result, risks for regional benchmarks such as the FTSE 100 remain firmly biased to the downside over the medium-to-long term.

Zero Bound Incentives

In general, global earnings have begun to falter as trade slows and export markets shrink. For global multinationals, these developments are disastrous as years of cost cutting and share buybacks have left companies facing a shortage of growth channels. While in the short-term these strategies helped improve returns for shareholders, over the long-term, the impact of these short-sighted policies will be felt with lower earnings potential and even raised default risk as companies took advantage of low interest rates to load up on cheaper debt financing. In the UK in particular, spending remains healthy and on the whole, the economy is rapidly improving as evidenced by lower unemployment, strong wage growth, and a substantial uptick in services consumption. Even though inflation remains low, these conditions have actually enabled the economy to improve further after years of inflation outpacing wages.

When interest rates are at or below the zero bound, incentives for investors dramatically change. Finding value in bonds and fixed income products is very challenging, leading to the hunt for yield. As a result, many retail and institutional investors are channeled towards riskier assets that provide potential for higher returns, but also magnified risks. However, for these institutions and retail investors, delivering stakeholder returns and generating income leaves few options on the table to satisfy the buy and hold mentality. Now that discussions are being held about monetary policy normalization over the near-to-medium term, the incentives are rapidly changing which could lead to a wider market re-balancing and one that saps demand for riskier assets such as stocks.