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The economist fund manager

Due to stock prices getting impacted by central banks' money printing, fund managers now also have to worry about macroeconomics

The economist fund manager

The year was 2005. Mutual funds were launching new fund offers dime a dozen. Almost every week there used to be a press conference at either the Taj Hotel at the Gateway of India or at the Oberoi Hotel on the Marine Drive.

Given that these new funds had nothing new to offer, the fund managers used to try hard to make a sales pitch. The pitch used to revolve around how they would be picking up different kinds of stocks or use a different method to pick stocks for this new fund. Ultimately, most new funds had nothing new to offer. This was just a way of raising more money, given the fascination of investors of getting more units at the launch price of ₹10.

Nevertheless, back then fund managers used to talk about stocks. While they were not allowed to talk about specific stocks, they used to make an effort to talk about sectors and the various methods they used to pick stocks.

I can safely say 11 years later that most fund managers don't talk about stocks anymore. This comes with the disclaimer that I do not have the same access to fund managers as I used to 11 years ago, given that I am no longer a part of the regular news media.

But from what I hear on television and read in papers as well as on the web, I can safely say, more and more fund managers now sound like macroeconomists. Most of the times they are trying to figure out and communicate in which direction the global economy, in particular the economies of the United States, Europe and China, are heading.

And you really cannot blame them for this. Given the fact that how their short-term performance is followed, they need to generate returns in the short term. In this scenario, it is important to figure out what is happening in the global economy. That will determine what central banks will do. Depending on what central banks do, foreign money will come into the stock market or go out of it.

Investing changed in the aftermath of the financial crisis that started in September 2008 after Lehman Brothers, the fourth largest central bank on Wall Street, went bust. In the aftermath of the financial crisis, Western central banks, led by the Federal Reserve and followed by the Bank of England, the Bank of Japan and finally the European Central Bank, started to print money.

This was done in order to drive down long-term interest rates. The hope was essentially on two fronts. At lower interest rates people would borrow and spend more. This would benefit companies and in the process help economic growth.

Further, as the former governor of Bank of England, Mervyn King, writes in his new book The End of Alchemy: Money, Banking and the Future of the Global Economy, "The immediate effect of a fall in the interest rates is to raise the prices of assets across the board." When interest rates go down, bond values go up. Also, with lower interest rates on offer on fixed-income financial products, investors are more likely to invest in the stock market. This drives up stock prices up. Higher bond and stock prices makes people feel richer. And this is where the hope is that wealth effect will come into play.

As people feel richer, they are likely to spend more and this, in turn, benefits the economy. This worked for a while and then it didn't. As King writes, "Monetary stimulus via low interest rates works largely by giving incentives to bring forward spending from the future to the present. After a time, tomorrow becomes today. Then we have to repeat the exercise and bring forward spending from the new tomorrow to the new today. As time passes, we will be digging larger and larger holes into future demand." There was a third impact of the low interest rates as well. Large financial institutions started to borrow money at very low interest rates and investing it in financial markets all over the world. When this flow of money comes into any stock market, the market rallies. Given this, it becomes very important for fund managers to keep track of the global macroeconomics and how it is playing out in order to do well in the short to medium term.

Also, it has led to a peculiar situation where bad economic news has become good news for the stock market. As Mohammed El-Erian writes in his new book The Only Game in Town, "The determined efforts of central banks and their unquestionable influence on financial assets have translated to markets operating under the mantra that "bad economic news is good for markets". Rather than lead to a downward revision in investors' assessment of fundamentals, and therefore, what constitutes fair financial value, disappointing economic news has been interpreted as implying that central banks will be even more engaged in repressing volatility, pushing asset prices to higher artificial levels, and by making people "feel richer," getting them to spend more." Hence, when there is bad economic news coming from the Western world, investors expect more money printing by the central banks to drive down interest rates. The entire idea of central banks, investors like to believe, is to make people feel richer and get them to spend. And this ends up driving up stock markets. In fact, even a reference to money printing can lead to markets running higher.

Recently, Janet Yellen, the chairperson of the Federal Reserve of the United States, said, "Even if the federal funds rate were to return to near zero, the Federal Open Market Committee would still have considerable scope to provide additional accommodation. In particular, we could use the approaches that we and other central banks successfully employed in the wake of the financial crisis to put additional downward pressure on long-term interest rates and so support the economy." What this meant was that, if required, the Federal Reserve would print money, as it had earlier. This statement immediately led to stock markets around the world rallying.

To conclude, in the world that we live in, if fund managers are looking for good short-term and medium-term performance, they need to be good macroeconomists, along with having an ability to pick stocks as well.

Vivek Kaul is the author of the Easy Money trilogy. He can be reached at [email protected]

This column appeared in the May 2016 Issue of Wealth Insight.