Rate cuts are encouraging risk taking, says Ian Lance, portfolio manager of the RWC Equity Income Fund
Central banks have sought to dampen volatility, but have made the financial ecosystem much more fragile. By continuously intervening at the first sign of a market correction, they send the signal that they will always backstop the market and thus encourage businesses and investors to take excess risk.
The build-up of these type of risks makes the financial system more fragile. It is impossible to know what event will trigger a sudden reversal in markets. All we do know, is that the more fragile the system becomes, the more likely it is that we experience some form of a re-set in asset markets.
Periodic market declines warn investors against taking too much risk and prevent more severe crashes. Conversely, a policy aimed at eliminating volatility will lead to complacency, and there has been a belief that markets will continue to rise, creating a feedback loop which means more credit drives asset prices higher.
During economic booms confidence is high, and is characterised by excess credit and high asset prices, but this results in poor market discipline and declining standards as confidence leads to excessive risk-taking. This is what we are seeing come to pass now.
