Its official, the Federal Reserve has begun a discussion to determine how and when it is that they will begin slowing down and terminating their controversial QE stimulus package. While the details surrounding the announcement were intentionally vague, the mere notion that the stimulus campaign is coming to an end will certainly stir up the markets to adjust for the lost inflationary value.
Combined with the way in which the policy’s termination can have a variety of different impacts across multiple different asset classes, economic indicators, and the ability of the economy to develop into the future, personal investors should take a minute to reassess how it is that the investment portfolios that they have developed over the last 4-5 years might now be in need of an adjustment.
Gold & Fixed Income Positions into Cash
Two of the biggest return-generators for investment portfolios over the last five years have been positions in gold and fixed-income bonds. With gold acting as a mechanism to protect wealth against inflation, and government bonds to protect investors from deflation, investors were in a position to make a return on assets that have been traditionally reserved for defensive compositions.
That being said, the high level of demand-side volatility coming forward as a result banks not carrying enough assets to back up their derivatives exposure, as well as the tendencies of central banks around the world to start selling off their gold reserves to shore up their own balance sheets, gold prices are starting to become as much of a risk-carrying asset as they are a defensive position. Combined with the way in which investors have been buying down bond yields on all ratings levels to all-time lows, the markets are starting to reach a point at which there is more money to lose in the protective positions than there is to gain. As the QE policies fade, investors can likely see American investment capital begin to shift out of these classes.
Dividend Paying Securities into Growth Positions
Alongside bond yields, investors have spent the last few years selling off their growth positions in favor of investments that generate cash flows. While a part of this trend stems from retirees looking to maintain the cash-flows that they need to support their lifestyles, another aspect of it comes from the way in which investors were looking to shift their equity portfolios away from volatility, and closer to stable returns. Even though these payments would then be diluted out by inflation over the long-term, they allowed investors to create a material investment return based on tangible metrics, as opposed to the irregularity of capital gains that are associated with modern markets.
From a fundamental perspective, the pursuit of predictability resulted in a situation where investors started paying unreasonable premiums for blue-chip securities, and playing unreasonable discounts on growth stocks. As the QE policies disappear, the value of these blue-chip positions will likely decline as a result of the increased discount rate that investors use to value the positions. To follow the same course of logic that put investors into these assets in the first place, it is logical to assume that these investors will consider selling off their blue chip securities in favor of growth positions, so as to (again) try and make up for the reduced returns of their portfolio. As such, a premium being placed on a portfolio’s ability to generate ‘home-made’ dividends is a serious possibility.