What's an investor to do?
Everything was going swimmingly until last week. Markets around the world were rising, and central bankers were firmly in control. The economic data in the US was improving a bit, but not so much you'd have to worry about the Federal Reserve cutting off the quantitative easing (QE) taps. It was Goldilocks' market territory not too hot, not too cold, but just right.
But then Fed chief Ben Bernanke seemed to have trouble working out whether or not QE was going to be ending soon. And some of his colleagues seem pretty keen to start withdrawing it.
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Now suddenly everyone is getting worried about the implications of rising bond yields and tighter money.
That's a lot of turmoil for one man to unleash. And it doesn't make managing your money any easier. So how do you invest in this environment?
Predicting the future is a mug's game but we all do it
It's not easy being an investor when you feel that you have to watch your back from every utterance from the likes of Ben Bernanke.
It was bad enough in the pre-credit crunch days when Alan Greenspan was in charge. Every monthly interest-rate setting meeting in the US was fraught with nerves as investors tried to second-guess whether Greenspan would twist or stick on interest rates.
But these days almost every bit of economic data is pored over for clues as to whether it means less QE or not. In Europe, every speech from Mario Draghi or any German politician of significance is monitored to try to work out if they plan to embrace money-printing over there.
And now in Japan, everyone's worried that the central bank hasn't yet stepped in to stop the slide in the stock market. Don't the Japanese know that this is the job of a modern central bank? To stop stocks from ever falling?
As I've said before, it's a little bit of a joke to describe any pricing system that hinges so much on the words of a few men (and the occasional woman) as a free market'.
I feel a lot of sympathy for anyone who'd rather opt out of the markets altogether in disgust.
But you can't spend your life sitting entirely in cash either. Nor can you stick 100% of your money in gold (although 5-10% does seem a sensible insurance policy).
The solution as far as I can see - is to try to ignore the noise, and look a bit further ahead than the next monetary policy announcement.
Predicting the future is a mug's game. But anyone who says that they don't invest with at least some sort of framework of assumptions about what they think might happen in the future is lying to themselves. Even a bog standard buy and hold and forget about everything else' strategy is assuming that this method of investing will still work. Which is not a given, by any means.
You should build a portfolio that is sturdy enough and diversified enough to thrive amid a range of outcomes, yes. But the mix of your portfolio is going to be influenced by what you think the biggest risks and biggest opportunities are.
What do central bankers want?
So trying to ignore the occasional market jitter, what is it that central bankers are trying to do? They all have their own obstacles to overcome, but mostly they want two things: a weaker currency and higher inflation.
A weaker currency ostensibly helps exports. This works better for some countries than others a weak yen is already helping Japan, whereas a weak pound has done virtually nothing for British exports.
But the real point of a weaker currency is to generate inflation. If you can't get real growth, then inflation is the next best thing. Inflation helps to get rid of debts the sneaky way and the world's developed economies have a lot of debt they need to get rid of.
Inflation is bad news for most bonds, because they pay a fixed income. It'll probably be even worse news for bonds this time around because yields are so low at the moment.
However, it could take a while for inflation to get going. Commodity prices are falling, which is probably the biggest good news story out there at the moment. It's not great for mining stocks, but it's great for anyone who uses raw materials or energy. Which is just about everyone.
On top of that, the US has shale gas, which makes it one of the cheapest places in the world for energy. That's a huge advantage, and probably one of the main reasons why the US is recovering from the slump reasonably well. Never mind QE, shale gas is a real, tangible boost to the economy.
So central bankers probably have a little bit of space to play with. Bernanke in particular, can point to fear of deflation to justify any continuation in money-printing. The underlying strength of the US economy also means it'll be hard to weaken the dollar against the currencies of other money-printing nations, regardless of how hard he tries.
History shows that a little bit of inflation is pretty good for equities, as my colleague Merryn Somerset Webb pointed out at the MoneyWeek Conference (and also in this week's editor's letter if you're not already a subscriber to MoneyWeek magazine, subscribe to MoneyWeek magazine).
But you can expect a very spiky ride along the way. And lots of un-nerving jolts. That's one reason why you have to make sure you have a sensible spread of assets in your portfolio so that you don't get panicked out of positions at precisely the wrong time.
My colleague Phil Oakley is building a long-term portfolio based on asset allocation and regular rebalancing just now find out more about Phil's Lifetime Wealth strategy here.
Lifetime Wealth is a regulated product issued by Fleet Street Publications Ltd.
This article is taken from the free investment email Money Morning. Sign up to Money Morning here .
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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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