Markets have finally been forced to face up to their worst fears.
The Federal Reserve confirmed that one day, within the foreseeable future, quantitative easing (QE) will come to an end.
The immediate outcome wasn’t pretty. Stocks slid. Bond prices slid, and yields jumped. About the only beneficiary was the US dollar – an end to QE means a stronger currency.
So what did Fed chief Ben Bernanke say? And what does it mean for your money?
The end of QE
Bernanke tried to explain to investors what the end of QE would look like.
QE has not changed as yet – the Fed is still pumping $85bn a month into markets. The point of this meeting was to explain how that’s going to unwind.
Investors had been hoping for some soothing words. After all, on some days in the last month, stocks have been going down, instead of up! They’ve got far too used to the idea of the ‘Bernanke put’ – they’d started to believe that stocks were a one-way bet.
But clearly, the carnage in emerging markets isn’t worrying Bernanke too much. US stocks haven’t plunged enough for him to be concerned yet. And even the weak inflation figures in the US don’t seem to be fazing him.
So, far from soothing investors, he gave it to them straight. The Fed thinks the US economy is on the mend. If that’s the case, then QE could start winding down within the next few months. And it’ll probably end in the middle of 2014.
Just to be clear – all this means is that the Fed will stop printing money to buy bonds. There’s no talk of selling any of the stuff that’s on its balance sheet, or of raising interest rates.
But markets still didn’t like it. At the start of the year, the story investors were telling themselves was simple. “Buy stocks. Because the money-printing won’t stop.”
That changed near the start of last month, as investors began to get the jitters that maybe QE wasn’t going to last forever. Now that it’s been confirmed, they have to re-evaluate everything.
So what’s the new story?
The new investment story
Here’s what the Fed’s decision means in short: US monetary policy – which has fuelled bubbles and rallies around the world – is going to get tighter faster than investors had expected.
Yes, Bernanke said everything depends on how the economy actually performs, so if the figures turn out to be really bad, all this may change. But markets operate on expectations. Bernanke gave a tougher speech than expected, so investors now have to adjust.
First things first, it means the ‘risk-on’ trades get reversed. We’ve already seen that happening. Money has been pulled out of emerging markets. And on the developing side, the hottest trade of the year – buying Japan – has also had the hardest crash landing as short-term bets were whipped off the table.
This is what happens when things change. Investors need time to gather their thoughts and regroup. So where does the money go next?
The clearest beneficiary is the US dollar, which we’ve been suggesting you have exposure to for a long time now.
On the downside, I’d keep steering clear of emerging markets for now. I’m not saying there aren’t individual good stories within emerging markets – there are always good stocks to be found. If anything there should be more good opportunities amid the rough weather ahead. And as they get cheaper, they’ll get more interesting again.
But things are being made worse for emerging markets by the fact that China is in trouble too. Growth is clearly slowing, and credit is getting tighter too. Among the most obvious casualties so far has been the Australian dollar, which finally seems to have embarked on its long-awaited date with reality.
Bonds in general still look too expensive. As yields rise, investors might be tempted back into US Treasuries (because they might be able to generate a decent ‘real’ return from them again). But other government bonds won’t enjoy the same natural support.
The strong dollar won’t be pretty for commodities, and like it or not, that includes gold. I’d still hang on to some gold as portfolio insurance though, as we keep recommending. The danger is that so many things could go wrong with unwinding QE that gold could rapidly regain its safe haven status if there’s a panic.
As for US stocks, the way I see it is that there are two competing forces here. On the bullish side, investors will want to own US assets, because the dollar is getting stronger; on the bearish side, US stocks are expensive by historic standards. So you have to be picky. Get your exposure via specific stocks and sectors. That includes UK blue-chips that earn a lot of money in US dollars.
Why the end of US QE could be good news for Japan
It’s not all bad news. There is at least one potential big beneficiary: Japan. The end of Fed money-printing means that Japan is now by far the most aggressive central bank in the world. The yen weakened sharply against the dollar yesterday, having strengthened a good deal in recent weeks. That’s likely to send the stock market higher again too.
Regular MoneyWeek contributor James Ferguson has been making this point for a while: QE weakens currencies but strengthens stock markets. So follow the money – buy Japan, and get exposure to the US dollar. Europe may well start down the money-printing route too eventually, which will be good for cheap eurozone stocks.
In the latest issue of MoneyWeek, out on Friday, our Roundtable experts talk about QE and some of the problems and opportunities we can expect to see as it’s unwound. If you’re not already a subscriber, you can subscribe to MoneyWeek magazine.
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