The Constant Investor: Sebastian Evans on the greatest risk for investors in 2017

Beware of contraction in debt market liquidity by Sebastian Evans 

 

The greatest risk to investors both domestically and globally would be a significant contraction in debt market liquidity levels, which will put downward pressure on equity markets. Over the course of the past 5 or so years quantitative easing programs in the US, EU and Japan have led to both a significant amount of increased liquidity within global bond markets, coupled with significantly lower interest rate levels.

As many of the major economies start to generate increased economic growth, increasing consumer and business confidence levels may well lead to increased wage growth. This can lead to a reasonable increase in inflation levels which will in turn lead to higher interest rate levels. The key consideration for investors over 2017 is how equity markets will be impacted by the potential winding up of many of the bond buying programs around the world, together with the rate at which interest rates are raised.

A further consideration for investors with regard to the above comments is how inflation levels interact with company earnings growth (i.e. generally earnings growth tends to be strong in times of rising interest rate levels) and the subsequent price to earnings valuation (P/E) ratios which are sustainable for company valuations. As current equity markets are trading on an above average P/E of 16 times it is imperative for earnings growth to be maintained at an average or above average level as well. A 1 point fall in the average P/E of equity markets would result in a 6.25% fall in equity market prices.

The Constant Investor FUNDamentals: Published 26 April 2017