Every six months the International Monetary Fund comments on global financial stability in its Global Financial Stability Report (GFSR) and the title of this post reflects both my own opinions over the last six month and the title of the IMF’s most recent GFSR published last week.
Given the profound financial instability that has rocked the world since 2007, the IMF’s assessments are important, and whilst we cannot ourselves do anything as individuals to improve financial stability we can take steps in our own financial affairs to mitigate risks and take advantage of opportunities identified by the IMF.
In essence, the report highlights the ‘challenging transitions’ taking place around the globe to bring the economy back to normal. Developed economies (the US, Japan and UK in particular) continue to be ‘supported by extraordinary monetary accommodation and easy liquidity’. The goal is to move away from this very artificial situation, to set aside these crutches and create a ‘normal’ environment and self sustaining growth, marked by increased corporate investment and growing employment.
This shift is most advanced in the US, but the transition is presenting challenges and risks. The IMF reports the risks of the increasingly extended ‘search for yield’ resulting in lower underwriting standards and increasing leverage (borrowing to buy assets with a higher yield than the cost of borrowing). This is a similar scenario to the pre-2007 economy, which is obviously of some concern.
Emerging markets face their own liquidity risks as capital outflows increase and China faces both growth challenges and stability risks from the over-extended shadow banking sector (another symptom of increased demand for credit at low rates).
Credit conditions remain difficult in Europe, especially those stressed economies in Southern Europe, not helped by the incomplete repair of bank balance sheets.
The IMF goes on to emphasis the need to maintain momentum and impetus for reform though the implementation of good policies ‘may prove challenging amid a crowded electoral calendar’ and the geopolitical situation in Ukraine could also pose a serious threat to financial stability if they were to escalate.
However, these are all risks, not certainties, and the other side of the coin is an improving economic situation especially in the US, the world’s largest economy. The IMF highlights this in its other major publication, the World Economic Outlook April 2014, which describes a strengthening, albeit uneven, recovery.
Given this picture of potential risks on the one side and potential opportunities for growth on the other, it remains important to maintain balanced multi-asset class portfolios protected against the downside risks and positioned to take advantage of the opportunities.
Lump sum investments should be phased over a period of time. Similarly, capital requirements should be taken gradually from portfolios. Given the risks around, it is important to hold liquidity for drawings required for at least three years. Its also probably not a bad time to increase long term investments through monthly savings as any volatility will help pound cost averaging.