SNAPSHOT

Why has everything been going up?

  • 25 February 2020
  • 5 minutes

The traditional movement of stocks and bonds appears to have been suspended over recent months leading to both stocks and bonds rising simultaneously. This has been a positive influence for many investors, but don’t expect it to last.

Normally, when the demand for and prices of stocks rise, the demand for and prices of bonds fall and vice versa. This is because stocks tend to carry higher risk and higher potential returns. So when investors are optimistic about the outlook, they are more likely to sell bonds and buy stocks. When they are pessimistic, they’re more likely to sell stocks and buy bonds.

Over recent years, this relationship has changed because of the activities of central banks such as the Bank of England and the US Federal Reserve. They have been electronically “printing” new money to buy low-risk rated investments such as government bonds. That has pushed more money into circulation, kept borrowing costs cheap, encouraged spending and helped to support company profits. As a result, stock prices have been rising.

At the same time, the extra demand for bonds that the central banks have brought, has sent bond prices up as well.

That all makes sense.

What didn’t appear to make sense started in October 2019.

The Federal Reserve had ceased its bond-buying programme, but bond prices were going up again. At the same time, the total value of assets owned by the Federal Reserve was also rising, suggesting that bond-buying was underway.

The Federal Reserve’s explanation was that its daily market intervention had been unusual. It was having to buy short-term T-bills (similar to bonds but with a much shorter life span) in order to make sure that there was enough cash available for banks to continue their normal operations. This is unusual because the Federal Reserve would normally be selling as well as buying rather than mostly buying day after day.

This is significant to investors because it continues to push bond prices up. At some point they have to come down. So while investors might have benefited from a simultaneous rise in stocks and bonds, that double-whammy cannot continue indefinitely.

There are at least three things to note here.

  • Firstly, the importance of holding a diversified portfolio which helps to limit the effects of a fall in stocks or bonds

  • Secondly, the need to be realistic about how long asset prices can go up.

  • Thirdly, we aren’t panicking because we anticipate these issues to be relatively short-term.

That’s why we focus on the longer-term horizon of around 10 years or more. It’s also why we don’t make major adjustments to our portfolio in the short term, even if the near-term outlook appears challenging.

Forecasts of future performance are not a reliable guide to actual results in the future; neither is past performance a reliable indicator of future results. The value of investments, and the income from them, may fall as well as rise and cannot be guaranteed and the investor might not get back their initial investment,

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