Investors on a joyride as the Fed keeps foot on accelerator
Markets, which had been expecting a reduction in stimulus, have fought back to multi-year highs, writes Max Mason.
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."