Investors on a joyride as the Fed keeps foot on accelerator
The sugar hit for financial markets might remain in place but US Federal Reserve chairman Ben Bernanke is confident that global investors will survive a rolling back of history's largest stimulus program.
To the surprise of most, the Fed this week decided against any sort of tapering of its massive bond buying program, instead choosing to continue the $US85 billion ($90 billion) injection into the US economy. At least for now.
In the eyes of Bernanke and the rest of the Fed board members, the US economy had not provided enough evidence to justify the central bank taking its foot off the accelerator.
Global markets reacted to this with a flurry of excitment spurred on by the prospect of cheap money remaining. Wall Street jumped to new record highs, with the Dow Jones Industrial Average adding 1 per cent and the broader S&P500 Index pushing 1.2 per cent higher immediately afterwards.
Australia's benchmark S&P/ASX 200 rose 1.1 per cent, while most European exchanges pushed about 1 per cent higher.
Emerging markets, which have been particularly buoyed by the Fed's stimulus, with cheap money feeding their economies, gained 2.2 per cent.
But these Thursday gains were short-lived with global markets drifting lower on Friday, lending weight to the suggestion that eventual tapering has already been priced into sharemarkets.
While in the near term the continuation of quantitative easing has the obvious benefit of pushing capital into riskier assets classes, such as equities. Long-term, there has been concern that financial markets have become addicted to easy money.
"I worry that below the surface things might be looking worse than what we've thought," said BlackRock's Australian head of fixed income, Steve Miller. "I don't think that's true but, given market psychology is a delicate thing, that might be a view that emerges over the next days or weeks, but it won't last."
When Bernanke first mentioned the possibility of tapering, markets around the world immediately sank. In the weeks after, Wall Street indexes slipped, on average, about 5 per cent, the Morgan Stanley Capital International Emerging Markets Index fell 16.7 per cent and the S&P/ASX 200 dropped 10.8 per cent.
"It used to be said that the central banker's role was to take away the punch bowl when the party was getting a bit too lively," Miller said.
"There were signs back in May when Bernanke mentioned tapering that the thing was getting a little lively. I think it was a useful shot across the bows - we've all learnt to be a little more cautious."
Since falling, markets, which had been expecting some sort of rolling back in stimulus, have fought back to multi-year highs.
The S&P/ASX 200 has pushed 13.3 per cent to five-year highs, Wall Street's Dow Jones and S&P 500 have jumped 6.7 per cent and 9.5 per cent respectively to new record highs, and emerging markets continue to recover lost ground, up 15.8 per cent.
Analysts credit these rises to the strengthening of fundamentals as companies recover from the global financial crisis. Australian companies, barring miners, have finally begun to shows signs of life.
In the short-term, a higher Australian dollar will cause headaches for local companies, which may struggle against overseas competition. But currency strategists predict the rise in the Aussie will be temporary. With the US economy grudgingly improving and tapering to occur at some point, the local dollar is set to ease.
Neuberger Berman director of investment strategy Matthew Rubin said the Fed's move, or lack of move, this week was one of caution, but he said the short-term and long-term outlook for US equities is positive.
Short-term, the central bank's move gives investors some level of certainty. In recent weeks, markets across the globe have been hit by headline volatility in the form of the Syria crisis, US fiscal issues and Fed chairman succession, not to mention the coming US debt ceiling.
"[In the long-term], we expect to see improved earnings growth, continued multiple expansion and strong margins," Rubin said. "In addition, the growth backdrop, both here in the US and in places like Europe, has been showing signs of improvement."
Emerging markets will have different challenges to face as they look to address reforms and debt reduction, which took a back seat while it borrowed cheap money.
Wingate Asset Management chief investment officer Chad Padowitz said tapering had no "juice left in the tank" to cause overheating among emerging markets.
"There are enough things to prevent excessive optimism in emerging markets, so I don't see it getting out of control," Padowitz said.
"I think it comes downs to whether they can do the various re-structurings and reforms that are needed to go from emerging economies to developed economies, which is very difficult and is far more complicated than anything to do with the US monetary policy."
Frequently Asked Questions about this Article…
The Fed decided not to taper its bond-buying program this week and continued its large monthly injection (reported as about US$85 billion, or roughly $90 billion). Chair Ben Bernanke and the Fed board said the US economy hadn’t yet shown enough improvement to justify taking the “foot off the accelerator.”
Markets initially rallied: Wall Street jumped (the Dow rose about 1% and the broader S&P 500 around 1.2%), Australia’s S&P/ASX 200 climbed about 1.1%, many European exchanges gained roughly 1%, and emerging markets rose about 2.2%. However, gains were partly short‑lived and markets drifted lower the following day, suggesting some tapering expectations may already be priced in.
In the short term, continued QE tends to push capital into riskier assets like equities by keeping borrowing costs low and supporting asset prices. The Fed’s move also provided some immediate certainty amid recent headline volatility (Syria, US fiscal issues, Fed succession and the US debt ceiling), which can calm markets temporarily.
Analysts warn markets can become ‘addicted’ to cheap money. Prolonged easy policy may mask underlying weaknesses in the economy or corporate fundamentals, increase sensitivity to policy changes, and create froth in asset prices — concerns voiced by investors such as BlackRock’s Steve Miller in the article.
When Bernanke first mentioned possible tapering, markets sank: Wall Street indexes slipped on average about 5%, the MSCI Emerging Markets index fell about 16.7%, and the S&P/ASX 200 dropped about 10.8%. Since then markets have rebounded — the ASX 200 rose about 13.3% to five‑year highs, the Dow and S&P 500 jumped roughly 6.7% and 9.5% respectively to new record highs, and emerging markets recovered around 15.8%.
A higher Australian dollar can create short‑term headaches for local companies by making them less competitive against overseas rivals. Currency strategists quoted in the article expect the Aussie’s rise to be temporary, and they anticipate it easing once US tapering eventually occurs.
Emerging markets have been particularly buoyed by cheap US money, and they face specific challenges such as the need for reforms and debt reduction that were deferred while borrowing was cheap. Wingate’s Chad Padowitz said tapering likely won’t have enough ‘juice left in the tank’ to cause overheating, but emerging markets still must address structural reforms to sustain growth.
Analysts in the article, including Neuberger Berman’s Matthew Rubin, view the short‑term and long‑term outlook for US equities as positive: the Fed’s move brings some certainty, and over time they expect improved earnings growth, continued multiple expansion and stronger margins as the growth backdrop improves in the US and parts of Europe.
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