10-Year Series Part 2: QE Addiction and the Non-Bank Credit Boom
In part two of the exploration into the ten critical themes shaping the global economic landscape, InvestSense and Hunt Economics delve into two interconnected issues: the QE Addiction and the Non-Bank Credit Boom. These themes present both challenges and opportunities for investors in the coming years.
Theme 3: The QE Addiction
The QE Addiction theme highlights the growing dependence of governments on Quantitative Easing (QE) to fund their budget deficits. Hunt argues that most OECD governments are now borrowing more than their households can or wish to save, creating a funding gap that requires either foreign help or some form of QE.
This addiction to easy money has created a cycle where markets have become heavily liquidity-driven, forcing investors to navigate QE/QT (Quantitative Tightening) mini-cycles. The expectation is that QE will return in 2024Q3, as the U.S. budget deficit widens and funding pressures increase.
Investment Implications:
Short-term:
- Monitor liquidity flows closely, as they are driving market movements more than fundamentals at present.
- Expect short-term market volatility due to QE/QT mini-cycles/fluctuations.
- Look for opportunities in bonds if/when QE is implemented in a more concerted manner.
- Anticipate currency fluctuations based on relative QE policies between countries.
Medium-term:
- Be prepared for distorted asset valuations IF QE takes hold.
- Consider more active sector rotation strategies if QE looks to be constrained towards cyclicals/value.
- Position fixed income portfolios cautiously given potential yield curve distortions.
Long-term:
- Prepare for potential long-term inflationary pressures.
- Consider the impact of potential currency regime shifts on international investments.
- Factor in debt sustainability concerns for long-term asset allocation.
- Develop strategies for an eventual end to QE, which could lead to significant market disruptions and ‘financial gravity’ where fundamentals matter more.
Theme 4: The Non-Bank Credit Boom
The Non-Bank Credit Boom theme explores the hidden leverage in the financial system, particularly in private markets. Hunt points out that official data doesn't fully capture the extent of non-bank credit and private flows, creating a potentially risky situation where debt levels are difficult to track and financial fault lines are difficult to perceive.
This sector involves multiple layers of leverage between banks, non-bank financials, private creditors, and the companies they fund. The system is highly dependent on liquidity and could face significant challenges if credit conditions tighten.
Investment Implications:
Short-term:
- Expect increased market volatility based on liquidity flows in the non-bank financial institution (NBFI) sector.
- Exercise caution and thorough due diligence in private credit investments.
Medium-term:
- Consider gradually reducing exposure to private credit and NBFI-related investments.
- Shift towards higher-quality, more liquid fixed income investments.
- Regularly stress test portfolios for NBFI sector contraction scenarios.
- Be prepared for eventual opportunities in distressed debt.
- Ensure sufficient portfolio liquidity to weather market disruptions.
Long-term:
- Prepare for a potential restructuring of credit markets as regulations evolve.
- Prioritise investments with clear, understandable structures and risks.
- Position portfolios for a more heavily regulated credit environment.
- Consider potential opportunities in traditional banking as regulations tighten on the NBFI sector.
- Renew focus on fundamental company analysis rather than financial engineering.
- Build robust risk management frameworks for potential large-scale market dislocations.
- Implement long-term inflation protection strategies.
- Seek out truly uncorrelated alternative investment strategies.
Both themes reveal an interconnected financial landscape where liquidity and leverage are central. Investors are encouraged to monitor liquidity flows closely, prepare for inflation, and build robust risk management frameworks to adapt to changing credit conditions.
Catch up on themes 1 & 2: China’s Minsky Moment and Asia’s broken model
Next week Andrew Hunt and Jonathan Ramsay will cover: The Future Isn't What It Was & Geopolitics.
