It might be all over.
In September 2012, the US Federal Reserve announced that it would buy $85bn worth of assets in the US market every month for an indefinite period. This was huge. The market instantly starting calling the move – the third round of QE (quantitative easing) since 2009 – ‘QE Infinity’. It seemed hard to believe that once started, a policy such as this could ever stop.
Well, it has. Yesterday, the Fed completed its QE taper – it had already cut the monthly spend to a mere $15bn and now it will do no more. Infinity, says the FT, lasted a mere two years. The Fed also changed the language a little in its statement to suggest that it might, one day, even raise interest rates.
We shouldn’t have to care about this stuff – in a sane world, the mutterings of central banks would mean nothing to long-term fundamental investors such as Moneyweek readers.
Sadly, the world isn’t sane…
QE recap
So, it’s worth just recapping briefly what QE has actually done to the markets we all rely on to finance our futures. In the US, QE has now been the main driver of the stockmarket for going on five years. That’s partly as a simple result of money being shovelled directly into markets.
The Bank of England explains their own almost identical quantitative easing process like this: “Central bank asset purchases, through this channel, push up the prices of the assets bought and also the prices of other assets. When the central bank purchases assets, the money holdings of the sellers are increased. Unless money is a perfect substitute for the assets sold, the sellers may attempt to rebalance their portfolios by buying other assets that are better substitutes. This shifts the excess money balances to the sellers of those assets who may, in turn, attempt to rebalance their portfolios by buying further assets — and so on.”
The bank – be it the BoE, the Fed or the Bank of Japan – shovels money into a market. That money then jumps from asset class to asset class sprinkling a little bubble magic on every trade as it goes. It is also partly because of the way the Fed has allowed companies to borrow practically free money to buy back their already over-priced shares: companies themselves have been the biggest buyers of their own shares for some time.
This hasn’t just happened in the US stockmarket. There, the bubble is the biggest. But asset prices across the board are higher than they would have been without QE. Whether QE has done anything for the economy at all is something that will be argued about for years to come – we’d concede that the first rounds saved the banks, which was handy, but we remain to be convinced that later rounds had much to give. Still, as a way of boosting asset prices, QE has been – as ex-Fed man Alan Greenspan puts it – “a terrific success”.
Impact on investors
So, what, then, does the end of QE mean for investors? First, we might note that this might not be the actual end of QE. What was once thought daring and experimental is now thought normal by markets.
If too much goes wrong, it will be back – let’s not forget that the Fed has announced the end of QE twice before, nor that John Williams of the San Francisco Fed has already said that he has “no problem” with going back to QE if the economy takes a turn for the worse.
There’s also super-QE under way in Japan and we still expect the same in Europe (unless central bankers suddenly become converts to the joys of deflation). But that aside, we do have a problem. If everything has gone up as one, notes Ruffer’s Jonathan Ruffer, surely there will be a “similarly widespread fall”. Surely.
It’s worth casting your mind back to a chart from 2011 that I keep in my mind all the time in an effort to make sense of everything (also produced by the Bank of England). It showed what the authorities expected to happen during the process of starting and stopping QE.
There was to be an ‘impact phase’ during the actual money printing, when nominal GDP and inflation would both rise a bit, but that asset prices would soar (this is exactly what has happened – the S&P is up by over 40% since the 2012 money printing began).
Then, there would be an adjustment phase post-printing, when asset prices would fall back to roughly where they started in inflation-adjusted terms as new money stopped being pumped in.
The world’s central bankers were exactly right on how QE would affect assets on the way up. I think it is a reasonable assumption that they might be right on what happens next too. Ex-CLSA analyst (and still one of the market’s most interesting strategists) Russell Napier has a view on this. Look back to 15 October, he says. The sharp fall in equities then was a hint of what a non-manipulated market might look like as market forces broke out for a few short minutes: “when the veil is lifted pay attention to what you see beneath.”
Napier thinks the future is deflationary – so he sees the true market as one of falling equity prices and rising bond prices. He may well be right, but those interested in how we can have so much money printing with so little inflation (the inflation rate has been pretty much unchanged in the US since 2012) might like to have a longer look at the report I provided a link to above: it shows an expectation that there would be almost no inflation in the impact stage, but that it would pick up smartly in the adjustment phase (the one the US is just entering): consumer prices would rise as asset prices fall.
We’ve had rising markets and disinflation for a while now. The Fed isn’t going so far as to actually reverse QE (it isn’t selling the $3.6trn worth of assets it has taken on since QE started), but nonetheless, perhaps this week is the kind of inflection point that suggests we will soon see the opposite. “If QE is history, most likely so is the bull market on Wall Street”, says our own Bill Bonner.
Buy some cheap gold
You might want to use the end of tapering as an opportunity to pick up some cheap gold just in case: as Greenspan told the WSJ this week, it’s a good place to have money “given its value as a currency outside of the policies conducted by governments”. I suspect that is one of the very few things on which Bill and Greenspan agree.
I had a conversation with a fund manager this week about how the rise of shale gas would, in the end, be a bad thing for the US economy. Why are you thinking about this, I asked. He was trying to find new ways to justify not investing in the US stockmarket. I see his point – and it’s an interesting one.
But, as private investors, we don’t need new ways to justify not wanting our money in US stocks. They are far too expensive and the impact stage of QE just ended. Until QE4 arrives at least, what more do you need to know?
Our cover story in the magazine this week is rather more cheerful. Jim Mellon runs us through his fabulous new book Fast Forward. Technology is speeding up and the world around us is changing faster than most of us have grasped. Whatever central bankers do or don’t do, we are headed for a world in which our children live until 150, we travel everywhere on super high-speed rail links and robots do all our dirty work. We want to be part of that and we want our money to be part of it too.
If you’re not already a subscriber to MoneyWeek, subscribe to MoneyWeek magazine. You won’t get this week’s magazine in print – the trial doesn’t start that quickly – but you will have full access to our web archive during the trial, and you’ll be able to read Jim’s article for free there.
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