Central bankers may have righted the ship, but investors are struggling to find returns and diversify their portfolios as stimulus distorts markets and fuels more debt, John Plender writes in this piece for the Financial Times.

Risk perception is out of whack: As ultra-low interest rates and stimulus squash bonds yields, turning many of them negative, the chances of investors making an equal return after reinvesting in similar assets is dwindling. This so-called reinvestment risk is pushing investors to enter riskier assets just to avoid seeing a fall in returns. This is what has allowed Italy — for all intents and purposes the new sick man of Europe — to sell 10-year bonds at a coupon of just 0.6%, or Greece — on the brink of default for half of the previous decade — to see its bonds turn negative.

Valuations are high across the board: The influx of liquidity into the system has also pushed up valuations across a range of asset classes and regions, making portfolio diversification increasingly challenging. Economists at the Bank for International Settlements point out that since 2018 the price of US treasuries, the traditional safe haven that pays off during a stock market sell-off, has actually dropped as equities have fallen. With only expensive derivative products or zero-income commodities to choose from, how are small-time investors meant to hedge effectively against stock market volatility? The answer is that many cannot.

And global debt is at record highs: Rock bottom interest-rates have also encouraged companies and governments alike to saddle up with even more debt. Global debt increased by USD 24 tn in 2020 alone, according to an Institute of International Finance Global Debt Monitor Report (pdf) bringing the total global debt figure to a stunning USD 281 tn by the end of the year, or more than 355% of global GDP.

This places central banks in a bind: They know that they need to raise interest rates to prevent the debt piles from growing, but doing that risks precipitating the exact storm they are hoping to avoid. You only need to look at the “taper tantrum” of 2013 — when an announcement by the Federal Reserve that it would begin phasing out its crisis-era bond-buying program prompted panic selling and a rise in US treasury yields — or 2018’s sharp stock market sell off in reaction to what was only a modest tightening cycle, to understand how the panic induced by rising interest rates in post-2008 markets.

“Investors’ most pressing financial concern should be the reality that the world economy is hostage to debt and wayward monetary policy,” Plender writes. In such a world, retail investors would be better served looking at real assets such as property and commodities, rather than government debt, which at best pays very little. The question for the meantime is whether a surge in productivity can begin to chip away at the debt pile, or whether central banks will instead depend on inflation to bring it under control.