Background noise

In the third decade of the 21st century, we are confronted with an oversupply of information. With regard to information on financial markets, even to such an extent that it is almost impossible for investors to process the quantity and cadence. The difficulty lies in assessing the relevance of all this information. The answer, however, is actually relatively simple: the bulk of the information has little significant impact on the capital markets, and yet we are forced to analyze it for its relevance. In today's world, investors no longer need to search for information, but rather have to determine the content and the potential impact on the overall economic environment, the markets and the individual asset classes. In doing so, it is necessary to differentiate which part of the information is merely background noise. How- ever, overanalyzing the endless flood of information can be tricky, as one might no longer see the forest for the trees. Another major challenge is to estimate how much of the relevant information is already factored into the individual asset classes.

The Fed’s rhetoric seems to contain lots of noise

At the center of the market noise is the US central bank. Not just since the Federal Reserve doubled its balance sheet from four to more than eight trillion US dollars, all eyes have been on?the Fed’s next steps. At first glance, the minutes of the last?FOMC (Federal Open Market Committee) meeting in late July, released last week, provided some new information. The Fed's monetary policy-making body discussed the timetable for tapering, respectively reducing its ultra expansive money supply. This, however, seems logical at this point in time and makes sense given the current economic trend. In addition, one member of the Fed’s panel –?James Bullard, Chairman of the St. Louis Federal Reserve?–?brought up a timely start to the reduction of quantitative easing (QE) and talked about a first rate hike. Again, investors had to process and assess an enormous amount of information. However, this only unsettled the markets in the very short term. On the one hand, since it is known that Bullard is a monetary policy hawk, and on the other hand, other Fed exponents immediately referred to the increasing uncertainty regarding the rapid spread of the Covid-19 delta variant.

n our view, much of the information here was also not more than background noise, because ultimately the markets only reacted to a limited extent and a first interest rate step by the Fed is still not expected for another 18 months (graph 1).

However, the Fed is acting very smart, because it is trying to sound out the water level, as to how the markets and the individual investment segments will react when the central bank money tap is turned off, so to speak. Our assessment remains as follows: whether the Fed starts tapering, i.e. reducing its asset purchases, three months earlier or later, or whether the interest rate hike cycle begins in 18 or 24 months, is not a real gamechanger. However, the consequence remains the same. Thus, equity markets are likely to face headwinds, as the rally has been primarily driven by liquidity and the outlook of continued monetary policy support. This means that selection in all asset classes will become even more important for investors.

Remain selective

In the past, capital markets have always struggled when liquidity drained up, or it has been gradually withdrawn. In our view, this time should be no different. In such market phases, a key?success factor is to be “very picky,” or selective. We expect this?to continue in the coming months. Likewise, investors should always have sufficient flexibility in their portfolio for this period, whether in form of cash holdings or very liquid investment instruments, in order to be able to benefit from opportunities.