Don’t fight the Fed has been an investing rule of thumb for many a year. Its popularity resurged in 2008 as major central banks around the world, led by the United States, lowered their countries’ interest rates towards zero in a bid to shore up economic growth.
What does this little pearl of wisdom actually mean? It suggests investors should buy equities when the US’s central bank, the Federal Reserve (the Fed), is lowering rates or pumping money into the economy. When the Fed stops however, or when they start to increase interest rates, it is the time for investors to reduce their equity exposure.
Put simply, this is because the Fed’s broad aim when lowering rates or injecting cash is to make it easier for businesses to borrow, thereby making it easier for them to expand and to generate extra profits. Which, in theory, should contribute to rising share prices.
Looking at the US stock market since the Fed adopted its ‘zero interest rate policy’, you’d say not fighting the Fed has turned out pretty well. British investors converting returns back into sterling would have seen a 211% increase1 over the period. (Of course, our currency has fallen so far in the past month that this has given all of our international returns a decent boost, but American investors have done well too, with US dollar returns of 166%2.)
So does the adage extend to other central banks? This Tuesday marked four years exactly since the European Central Bank’s (the ECB) president, Mario Draghi, declared in front of a room full of business leaders and investors, that the ECB was ready to do “whatever it takes to preserve the euro”.
Following this up with rather dramatic flair, Draghi then said: “And believe me, it will be enough.” Clearly the mission is still in progress, given the ECB announced yet more economic stimulus earlier this year – this time in the form of corporate bond buying for the first time in the institution’s history. Again the goal is to encourage as many companies as possible to borrow money and to invest.
But have British investors been right not to fight Draghi? So far so good, it looks like. Total returns in sterling from European equities since the era of “whatever it takes” begun in July 2012 have been 72%3 (61% in euro terms4). The FTSE 100 has only delivered 39% over that same period5.
Time to change tack?
The question now, though, is should you stick with the traditional wisdom or has the time come to change tack? The current investing environment is highly unusual to say the least. Rates have been falling around the developed world for some 30 years and have spent nearly a decade now at zero or close to. And while this has boosted share market returns, there’s mixed evidence as to whether they have really had the desired impact on economic growth.
Central bankers have been pushed towards more and more experimental measures, whose effects on the stock market are as yet untested. So what’s the best way to make sure you have some exposure to the growth potential in a region such as Europe, while minimising the risks inherent in investing in such uncertain times?
My take on the matter is that your focus needs to be as much on avoiding the losers as it does picking the winners. Under the bonnet of the European Union are many different nations whose economies are, in fact, performing quite differently and with different growth drivers. One good way to give yourself the best possible chance of success is to invest in funds that leave the stock picking to the professionals, while you simply choose the themes to which you wish to gain access.
For example, the Elite Rated BlackRock Continental European makes for a strong, core Europe holding, which aims to take advantage of broader macroeconomic themes. Or, a particularly defensive option is the Threadneedle European Select, also Elite Rated, which has outperformed in down markets.
If you want to pursue a more aggressive growth strategy, you could also allocate some of your portfolio to Europe’s smaller and medium-sized companies, many of which are often overlooked by investors despite the fact that they may be global leaders in their fields. The Elite Rated Baring Europe Select is one such fund, whose manager, Nicholas Williams, scours the small and mid-cap space with a firm focus on stock fundamentals. I also like the Elite Rated T. Rowe Price European Smaller Companies.
1FE Analytics, S&P 500, TR in GBP, 16/12/2008–25/07/2016
2FE Analytics, S&P 500, TR in USD, 16/12/2008–25/07/2016
3FE Analytics, Euro STOXX, TR in GBP, 26/07/2012–25/07/2016
4FE Analytics, Euro STOXX, TR in EUR, 26/07/2012–25/07/2016
5FE Analytics, FTSE All Share, TR in GBP, 26/07/2012–25/07/2016
Past performance is not a reliable guide to future returns. You may not get back the amount originally invested and tax rules can change over time. Darius’ views are his own and do not constitute financial advice.