This was what we would come to know as QE1 and, it was swiftly followed by QE2 in November 2010 and then in September 2012 along came the equally ingeniously named QE3. By this point the Fed was pumping $40 billion per month into a bond purchasing program which it then raised to $85 billion. The UK joined the buying frenzy in March 2009 and we now have £375billion of UK Government securities as part of the Bank of England’s QE program. This equates to around 24% of annual GDP, in the US it is equivalent is around 20% of US GDP and in Europe the ECB holds around 30% of European GDP as part of the Long Term Refinancing Operations (aka QE).
Light at the end of the tunnel
Also, I’m sure that it has not passed you by that March 2009 was another significant point for investors; the S&P 500 and many other indices bottomed out post the 2007 crash and started to climb higher. In fact they pretty much kept climbing, with the exception of the odd wobble out of Europe, until Ben Bernanke introduced us to another phrase that would dominate our lexis, “tapering”.
If, like me, you scrambled for the Oxford English Dictionary, you would have been somewhat perplexed to find that tapering refers to the practice of reducing exercise in the days prior to an important competition, apparently essential for optimal performance. You can understand why so few financial market participants had heard of it.
Anyway, the point I am trying to get to is one where I can rationalise this series of events. The Fed Chairman said that if the US economy continued to improve in line with their forecasts then it would be possible to reduce the amount of QE on a month on month basis from $85bn to $65bn. However, this was contingent upon positive economic data, specifically 3% growth in the second half of this year with a trajectory of 3.4% next. Great news! The end of artificial liquidity management, the worst is over, light at the end of the tunnel….. No. US market off over 5%, UK down nearly 10% and Japan some 20%.
Bubble territory
What was I missing? What was the market telling us? Or, perhaps in this case, what was the world’s most powerful central banker telling us? Was a new all time high in US equities and his announcement linked in any way? Whether you think current valuations are justified or not, recent events have a certain “we will do what it takes” or “irrational exuberance” moment about them. The market is supposed to be a forward looking indicator of business activity, economy prosperity and investor sentiment. A discounting mechanism reflecting the efficient-market hypothesis. Perhaps what we should read into the statement is more straightforward – risk assets have rallied too far and too fast and in danger of heading into bubble territory.
If the last five years have taught us anything it must be that controlling the macro environment is at best problematic. Trying to predict economic outcomes, never mind markets, when we simply don’t understand what real affects the current strategies deployed by Central Banks and politicians are having, is pointless. In this environment it is essential that investors focus on finding high quality companies with strong fundamentals and compelling business models. Pick managers who can explain how they add value through stock selection and are prepared to deviate from the index. If you think you can second guess the market, buy a tracker but, at the risk of stating the obvious, you will get a market return and if you are still in some doubt look at where the FTSE100 was 15 years ago.
Patience rewarded
Recent events have reminded us that markets never go in a straight line. However, as we look forward into the second half of 2013 and beyond, my assessment is that many companies have the potential to deliver good real returns over the medium to long term. My other assertion would be that government bonds are much less attractive when looking over a similar time frame. Notwithstanding the recent pull back in markets, I continue to see significant stock specific opportunities which give grounds for optimism especially for the patient investor. I think that quality stocks will continue to do better than value and that cyclicals will do better than defensives and having global diversification will also be key to mitigating risks.
There are numerous macroeconomic and political challenges facing governments and financial institutions around the world. The fine line between stimulating growth whilst trying to reduce the overall level of debt is ongoing and will shape policy across the globe for many years to come. This is reflected in the short-term movements of the market indices which will remain volatile at least until the timetable and extent of the QE unwinding are clearer.
I would welcome a move to a more normalised system of global liquidity as this would signal a move back to higher levels of economic growth which will help balance budgets and improve investor sentiment. However, this course of action is not assured, and any move to halt tapering and increase QE would indicate that global economies are once again faltering, and require artificial support from the world’s central banks. Both these outcomes could push the market higher in the short term, although it is only the removal of QE that will herald the return to a sustainable recovery for the global economy.
