Everyone likes to go out on a high note.
And Ben Bernanke, the outgoing head of the Federal Reserve, must be feeling pretty pleased with himself today.
Yesterday, the Fed finally decided to start the dreaded taper. In May, when the Fed even hinted at pulling back, markets went into fits of panic. But last night, they surged.
What’s going on? And how does it affect your portfolio?
Five years on, and the money is still flowing
It’s been just over five years since Lehman Brothers went bust. In that time, a lot has happened. It’s easy to lose perspective.
So let me take you back a bit, if I may. Do you remember the first time you heard about quantitative easing (QE)? And what you thought at that point? I suspect it probably went along the lines of: “Central banks are printing money? Seriously?”
Now imagine what you would have thought if I told you they’d still be at it in five years’ time.
The global banking bubble popped in 2008. And as of the end of 2013, short-term interest rates in every major developed economy are below 1%, and the biggest economy in the world is still printing $75bn a month to buy its own debt, among other things.
That’s quite sobering really. And it’s just a reminder amid the day-to-day hype of the market, of quite how far away from what we once deemed ‘normal’ our current system has become.
With that in mind, what happened yesterday?
The Fed decided it will buy $75bn-worth of bonds a month, split between mortgage-backed securities and US Treasury bonds. That’s a drop from $85bn a month. Meanwhile, Bernanke was keen to say that interest rates will stay low for a long time to come – “well past the time that the unemployment rate declines below 6.5%”.
Basically, he’s saying that it’s time to stop doing QE. There are lots of side-effects the Fed is a bit worried about – the fact that it would be a bad idea to own every Treasury on the planet is possibly among them.
But that doesn’t necessarily mean that monetary policy is getting tighter. The Fed – under Janet Yellen – is ready to step in if it looks like things are turning down again.
I believe the technical terms is “having one’s cake and eating it”. And the message to Wall Street is: “Don’t freak out. The Fed still loves you.”
In short, for now, markets see this as the ‘Goldilocks’ taper. The fact that the Fed can do it, suggests the economy is getting better. But it’s doing it so slowly that monetary policy still remains very loose indeed. And the Fed is also reassuringly open to loosening again.
What does this mean for your portfolio? Probably very little
So what does all this mean for your money? The short answer is – not really very much. We’ve known the taper was probably coming. We’ve known that it would be couched in language that tried to reassure the market that rates would stay low regardless. So while the exact timing was always unsure, some form of slowdown in the rate of money-printing was likely.
Now the Fed might be able to fool markets for now. But like it or not, this is a move in the direction of tightening, not loosening. And given that money-printing is what has kept the S&P 500 roaring forward in recent years, I can’t see that stellar rise continuing.
US stocks are expensive compared to history. (Although there’s a key exception, which James Ferguson flags up in this week’s MoneyWeek magazine roundtable). In the absence of QE, there’s nothing to keep them going up. I’m not saying they’ll crash – but I do think they need to get cheaper.
There are lots of other potential impacts. I’ll be looking in particular at the bond market and potential liquidity problems there in the New Year. And in the longer run, the real risk – and the one thing that seems more certain than anything else – is that the Fed won’t tighten quickly enough and our next crisis will be inflationary.
But overall, if you’ve been reading Money Morning for the past year or so, I don’t see that anything massive has changed.
Stick with cheap markets where money-printing is ongoing (Japan) or possible in the future (Europe). Have a bit of gold in your portfolio in case of emergencies – there’s a good chance it will have another miserable year ahead, but that’s rather the point of diversification. Take a look at index-linked bonds, but avoid most conventional ones.
The key ingredient for a long bull market – a long bear market
Getting back to my favourite subject of the moment – Japan – what I really like about it is that there’s still a surprising amount of scepticism out there. Markets are usually extraordinarily quick to change their minds according to price action. When something starts to go up fast, people pay attention, and the supply of bears to be converted to bulls diminishes rapidly.
But – as with gold in the early 2000s – when a market has been ground down for literally decades, the bears die hard. And it seems that’s the case for Japan too. I’m not saying it’s a radical contrarian bet by any means. But nor is it the front-page-hogging ‘no-brainer’ that usually indicates that the end is nigh.
There are still plenty of people out there saying “yes, but…” about Japan. This week, the FT had a big column from Martin Wolf on why Abenomics will fail. And there’s another column today arguing that there still isn’t enough lending going on.
Long may the scepticism continue. That’s what gives you the big bull markets. And goodness knows we’ve waited long enough for one in Japan.
However, while it’s my big bet for 2014, it’s far from being the only attractive market out there just now. Make sure you read the latest issue of MoneyWeek magazine, out tomorrow. It’s the last issue of the year, when we get our Roundtable experts together to give their views on the best investments for the year ahead.
They have plenty to say on how the taper could affect markets in 2014, and of course, a pile of share tips too. If you’re not a subscriber already, subscribe to MoneyWeek magazine.
Our recommended articles for today
There are five unavoidable forces at work today that mean millions of people could be looking at a miserable retirement. Bengt Saelensminde explains what they are.
The once mighty city of Glasgow has become a social and economic disaster zone. But throwing public money at it isn’t the answer. In fact, it might have been the problem all along.