It's a big week for central banks. And that makes it a big week for investors too.
We've got the Federal Reserve announcing the results of its latest meeting today. They're not expected to do anything. But their views will be watched closely for any hint that more quantitative easing is in the pipeline.
Then Japan's central bank meets on Friday. Unlike the Fed, they are expected to do something. Indeed, if the Bank of Japan fails to follow up on its February promise to print more money and return Japan to inflation, investors will be very disappointed.
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The good news is that if you can cut through the noise, then this could present you with some worthwhile investment opportunities
The incredible power of central banks
Investors have learned to pay close attention to central banks' actions. In fact, many investment decisions are now dictated not only by what central banks actually do, but by what they hint at doing. Considerations of what's going on in the real' economy come second.
This is a ludicrous state of affairs. There's a very telling line in a piece in the FT this morning, by Takatoshi Ito, professor of economics at the University of Tokyo.
In the piece, Ito is talking about the Bank of Japan (BoJ), and how it needs to convince investors that it's serious about driving inflation higher. We'll have more on that in a moment, but this is the line that really hit me.
Talking about the power of monetary policy, he says: "In the long run, it is the central bank that determines the level of prices and the central bank that influences inflationary expectations."
Think about that for a moment. We pride ourselves on our capitalist, market-driven system. Yet here's an open acknowledgement that prices are set centrally by a small group of men, sitting in an office in a capital city, and making guesses at what might happen to the economy next.
It's not quite as damaging as dictating where crops should be grown, or setting annual quotas for tractor manufacturing. But if you think that this system doesn't distort investment decisions, or lead to massive capital misallocation, then you're deluded.
We argue that markets are the right way to set the price for everything else. But when it comes to the most important price the price of money - we take markets out of the equation, and hand the power to central planners.
I hope that one day, we'll look back and wonder what we were thinking. But in the meantime, this is why investors can't ignore what central bankers are getting up to.
The Federal Reserve's words will be watched closely
So what are they doing now? The Fed has been holding its equivalent of the Bank of England's Monetary Policy Committee meeting over the last two days. It's due to announce its latest views on interest rates tonight, just after seven.
Nothing will change. Interest rates will certainly stay where they are. And with the US economy looking a bit stronger recently, the option of more quantitative easing (QE) is almost certainly off the table for now.
However, with markets getting the jitters over Europe, everyone will be desperately looking for a hint that Ben Bernanke and chums haven't completely ruled out QE.
A hint at more QE would weaken the dollar and boost stocks. On the other hand, any suggestion that rates might rise before 2014 would send the dollar surging, and probably batter stocks and gold.
I've already written about the problems facing the Fed this year. With an election coming up, it'll be tough for them to justify QE unless there's a major market panic. So it'll be steady as she goes for now.
But in the longer run, another panic is likely. That would mean more money printing. And that's a good reason to make sure you've got some gold in your portfolio as insurance.
But the Bank of Japan is the most important meeting this week
However, the really interesting meeting this week is happening in Japan. In February, the Bank of Japan (BoJ) surprised investors by adopting an inflation goal' of 1%. It also boosted its QE efforts.
This got investors very excited. As James Ferguson recently wrote in MoneyWeek magazine: Why Japanese stocks are set to soar, the strong yen has been one of the biggest pressures on the Japanese economy. If the BoJ could weaken the yen, the earnings of exporters would rocket.
The BoJ's actions helped the Japanese stock market to a stellar performance in the first quarter of the year. It also sent the yen lower. But with investors starting to worry about Europe again, the yen has been strengthening once more. And doubts are creeping in about how serious the BoJ is about actually committing to inflation.
If we don't see some significant action this Friday, the yen will probably surge, and Japanese stocks will likely drop.
So what are you meant to do about this? Well, unless you're a trader, I don't think you need to worry. As far as I'm concerned, Japan is a buy either way.
Here's why. Firstly, if the BoJ doesn't disappoint, then Japan will get some momentum behind it. Investors will start to believe that the time has come for a major turnaround. That'll be great for Japanese stocks.
And if it disappoints the market, and stocks fall? Well, I'd take the chance to buy some more. Because the Japanese government is getting increasingly aggressive and fed up with the BoJ's refusal to follow the Fed and other Western central banks. The initial BoJ action was almost certainly the result of political pressure. If they fail to follow through, that pressure will only increase.
Secondly, and more to the point, the big difference between Japan and US stocks as a whole, is that Japanese stocks are cheap. As one of the experts at our latest Roundtable pointed out, US stocks look richly valued'. With Japan, on the other hand, you get a decent margin of safety' so your downside is lower.
You can read the piece in the next issue of MoneyWeek, out this Friday. If you're not already a subscriber, subscribe to MoneyWeek magazine.
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John is the executive editor of MoneyWeek and writes our daily investment email, Money Morning. John graduated from Strathclyde University with a degree in psychology in 1996 and has always been fascinated by the gap between the way the market works in theory and the way it works in practice, and by how our deep-rooted instincts work against our best interests as investors.
He started out in journalism by writing articles about the specific business challenges facing family firms. In 2003, he took a job on the finance desk of Teletext, where he spent two years covering the markets and breaking financial news. John joined MoneyWeek in 2005.
His work has been published in Families in Business, Shares magazine, Spear's Magazine, The Sunday Times, and The Spectator among others. He has also appeared as an expert commentator on BBC Radio 4's Today programme, BBC Radio Scotland, Newsnight, Daily Politics and Bloomberg. His first book, on contrarian investing, The Sceptical Investor, was released in March 2019. You can follow John on Twitter at @john_stepek.
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