The end of QE spells opportunity for cool heads

As the end of QE approaches in the US, investors are getting nervous. But for those who can keep calm while others panic, these are exciting times, says John Stepek.


No expectation of a QE4' in the US

It's the month we've all been waiting for.

Soon we find out just how big a deal the taper' will prove to be.

Investors have been fretting about this since May. And there are plenty of good reasons why the beginning of the end of quantitative easing in the US could turn ugly.

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But it could also spell opportunity for those who can keep cool heads while everyone else is panicking

Investors are hunkering down in preparation for the end of QE

Investors clearly fear the taper'. No wonder. In the last four years, the Federal Reserve and other central banks have pulled off a clever trick.

Everyone seems to agree that quantitative easing (QE) printing money to buy bonds - has driven up asset prices. But in all that time, I've yet to come across anyone with a definitive explanation of the precise mechanics of how it has done so.

Ask a dozen experts for their view on how QE works to drive asset prices higher, and you'll get a similar number of explanations, depending largely on their own political and economic biases.

Some people say it does nothing. It's all a con trick. Others argue that it's all about suppressing the risk-free' rate. By keeping the price of government bonds high, and yields low, it forces everyone else to buy more risky stuff to make a decent return.

Still others argue for the pass the parcel' theory that when the central bank buys bonds from a pension fund, the pension fund has to buy something else with the money. Thus the cash shifts into other assets.

For me, this last answer is the most convincing. But whatever the exact mechanism of QE, the point is that it's about to be withdrawn from the biggest bond market in the world.

Investors can be forgiven for worrying. On both of the previous occasions that QE was withdrawn, markets coped badly without it. That's why QE2 had to be launched not long after QE1 ended. And that's why QE3 kicked in after QE2 was over.

This time around, there can be no expectation of a QE4'. The whole point of QE3 is that it was designed to go on until the economy was able to stand on its own two feet.

The Fed now believes that time is near. We'll get a bit of a better idea of just how near at the end of this week, when US unemployment data comes out. But unless the figure is well out of line with what markets expect, it's hard to see it making a material difference to the Fed's decision.

Money is flooding out of emerging markets

The end of QE in the US is what lies behind most of the recent upheaval we've seen in the markets. Money has been sucked out of emerging markets as investors retreat from risky bets. Some of the nations that were going to be giants of the future are now being entirely written off by the same pundits who ramped them up in the first place.

Demand for physical gold has jumped up. As John Dizard points out in the FT's fund management supplement this morning, retail investors have been snapping up physical gold in preference to exchange-traded funds, for example. "The world's retail gold buyers appear to be more motivated by distrust of banking systems and concern about capital controls than they are by fear of inflation."

This of course, is a sensible concern to have, and it's one reason why we think you should always own some gold in your portfolio to insure against these and similar risks.

Finally, even the US stock market has taken something of a dent in the past month or so, as my colleague Dominic Frisby noted the other day. And quite right too on long-term measures, the US stock market is among the most overvalued in the world.

Stay calm there's no profit in panicking

There's nothing wrong with being nervous about the state of the markets. It's good to be wary. That helps to stop you from making stupid mistakes born out of over-confidence.

But as I noted last week, it also makes no sense to turn your entire portfolio over to cash every time there's a sniff of fear in the air.

Yes, if you have some speculative punts that you took earlier in the year that you haven't sold yet, you might want to revisit those. If your reasons for buying them are still intact, fair enough, hang on. If you were just hoping to turn a quick profit on them, then you may have to cut your losses and accept that the best time to sell is now past.

But if you're looking at investing for the long term, then this is the kind of market that should start to get you excited. Because now's when you get the chances to top up positions in your preferred markets on the cheap.

For example, everyone might be worrying about the end of QE in the US. But if it's money-printing you're after, there's still plenty of QE going on over in Japan.

Just as in the US, Japan's housing market is finally recovering. Unlike in the US, prices remain at very low levels compared to their peaks. According to the FT, "the cost of 3.3 square metres of land on the most desirable street in Aoyama [an upmarket bit of Tokyo] is still less than $310,000, down about 80% from the 1990 peak." It might have been overvalued at the peak, sure. But there aren't many assets in the world that are 80% below where they were (in nominal terms) 23 years ago. You can find out more about how to invest in Japan in our most recent MoneyWeek magazine cover story on the market.

And for those with an appetite for adventure, in the next issue of MoneyWeek, out on Friday, my colleague David C Stevenson will be looking at some of the best ways to play a rebound in China. If you're not already a subscriber, you can subscribe to MoneyWeek magazine.

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John Stepek

John Stepek is a senior reporter at Bloomberg News and a former editor of MoneyWeek magazine. He graduated from Strathclyde University with a degree in psychology in 1996 and has always been fascinated by the gap between the way the market works in theory and the way it works in practice, and by how our deep-rooted instincts work against our best interests as investors.

He started out in journalism by writing articles about the specific business challenges facing family firms. In 2003, he took a job on the finance desk of Teletext, where he spent two years covering the markets and breaking financial news.

His work has been published in Families in Business, Shares magazine, Spear's Magazine, The Sunday Times, and The Spectator among others. He has also appeared as an expert commentator on BBC Radio 4's Today programme, BBC Radio Scotland, Newsnight, Daily Politics and Bloomberg. His first book, on contrarian investing, The Sceptical Investor, was released in March 2019. You can follow John on Twitter at @john_stepek.