Beware the ‘Central Bank Put’
By Mohamed El-Erian
Financial Times, London
Monday, January 7, 2013
The investment recommendations made by many financial commentators are now dominated by cross-asset class relative valuation rather than the fundamentals of the investment itself. A typical refrain runs something like this: Buy X because it is cheaper than other things out there.
This is an understandable approach as unusual central bank activism has artificially elevated certain asset prices. Yet the dominance of this increasingly popular advice comes with potential risks that need to be well understood and well managed.
Several asset classes now have highly manipulated prices due to experimental central bank activities, both actual and signalled. The more this happens, the more investors come under pressure to migrate to higher risk investments in search of returns. Ben Bernanke, Federal Reserve chairman, said as much at his latest press conference, noting that the aim of policy is to “push” investors to take more risk. True to his wish, many pundits seem eager to discard fundamentals in favour of searching for (and levering) anything that “yields” more.
This situation is reminiscent of 2006-07, when hyperactive liquidity factories also pushed some asset prices to artificial levels, thus contributing to a generalised and indiscriminate compression of risk premia. In the process, investors were comforted by the then-popular notion of the Great Moderation (the belief that central banks and governments had conquered the business cycle). We all know what happened next.
This historical parallel is not perfect, however. As I wrote in March 2007 in the Financial Times, the liquidity factories then were endogenous to the markets. Leverage was created by private participants (particularly investment banks) taking on greater risk.
Read More at gata.org . By Mohamed El-Erian.