With the winding down of the Federal Reserve's bond purchase program and expectations for rate hikes in 2015 likely to be realized, investors will reassess their risk positions. Over the past several years, investors have taken solace in the support central banks have provided the financial markets. In the U.S., yields on junk bonds remain close to historically tight levels, equity prices are hovering near all-time highs, and bank earnings are robust, despite the enormous fines the government has levied since the financial crisis.
Investors who have relied on quantitative easing as the basis for many of their investment decisions have been well-rewarded. Further, the riskier the assets, the stronger the performance has been. During this period, bad news for the economy has been viewed as good news for the markets given it meant either an increased level or extended period of stimulus. We believe investors' views today are in the process of changing. Investment decisions, at least within the U.S., must again stand on their own merit, not central bank support.
As we think about investments going forward, we need to think hard about which asset classes have benefited primarily from investment flows driven by yield-hungry investors being pushed out the risk curve and which actually have fundamentals that support their current pricing. Clearly, the market is questioning the ability of companies with weak balance sheets and questionable business models to survive in an environment of tepid growth. The days of rising tides lifting all boats are over. This process of differentiation will create the next wave of thoughtful investment opportunity for the upcoming year.