First person: The QE hangover

The demise of quantitative easing should be a good thing, but investors have become hooked on the benefits the influx of money brought. Now they are worried about what might transpire in a post-QE world
by Anthony Hilton FCSI(Hon)

We live in a zone of anxiety. According to a 2013 study by the behavioural team at Barclays Wealth, none of us live in the long term; we are always buffeted financially and emotionally by short-term uncertainty.

We should try to take a long-term view. As part of its study, the Barclays team looked at the MSCI World Index of developed equity markets in 24 countries and plotted it for more than 40 years from 1970. It then made a heat map to analyse what an investor would get. 
It showed that any potential losses were all short term, whatever period was taken, and the bulk of them happened in the two years from starting to invest.

On the other hand, all investors showed a profit in, at the most, 12 years – assuming they did not sell out. That was the extreme; almost all the combinations, in fact, showed a profit after just five years, however bad the markets and high the investors’ shares might have been to start with. There was only one occasion when it took more than ten years to get into profit, and that was the 12 years just mentioned. 

Provided you have a diversified portfolio and hold for the long term, it does not really matter when you buy. There are highs and lows in the market, but they become less and less significant with every passing year. 
A wall of worryThat ought to be the end to the matter, but markets always have to endure a wall of worry and currently they are anxious about quantitative easing –  or rather they are worried about the opposite. 

Central bankers have been funnelling in huge amounts of stimulus for ten years now after the financial crisis, but it is coming to an end. Indeed, the US has already taken some steps to raise interest rates.

This ought to be a plus for investors because it should mean that the economy can stand on its own two feet without the added stimulus. That is certainly the central banks’ view. But instead many people seem to be hooked on excess, rather like any other addiction – they know they ought to stop, but not now. The rush of money has caused a huge surge in markets and if that comes to an end, what will happen to prices? To quite a few investors, it does not bear thinking about. 

"The point is something somewhere will light a flame, but we do not know when or where"In addition, a large number of companies in emerging markets have borrowed heavily thanks to low rates and the flood of money. The debt (largely in dollars) is a multiple of what it was before the financial crisis. The trouble is that some of these entities cannot cope with the higher rates that are likely to materialise and that will cause a cutting back of investment, a cutting back of production, and even bankruptcy. That would put severe pressure on those markets.

The other aspect of this is the huge growth of passive investing, where practitioners think shares are going to go up and active investing is not worth the candle because any gains are likely to be absorbed by costs. What they do not think of is the downside – a bear market, when passive investors are guaranteed to lose money but active investors might make a profit. 

Hendrik Bessembinder, an American economics professor, shows that most stocks entering an index ultimately go out again and people would be better off buying Treasury bills than they would letting these shares run their course.
Different theoriesBut that only works if you are an index tracker or the concomitant of that, such as an exchange-traded fund or some smart beta strategies where the investor is also locked in. It should not apply to active stock pickers because they can harness the growth that comes from the first beginning and the final exiting of the share.

However, some passive investors have a different theory. They have come to believe that the central bank will somehow always make things right so passive investment will also always be right. Even if the banks raise interest rates, it will be by less than expected so that the boom can continue. Thus, there is no need to worry – or so they would have us believe.

No one knows what will transpire; it may be that quantitative easing causes a crash or it may be something else, be it a credit crunch or something completely different like a flash crash. The point is that something somewhere will light a flame, but we do not know when or where. Many people believe that the bull market is growing long in the tooth so it is ready for a correction, but even they do not know when it will be. Others simply do not believe it any time soon. 

The original version of this article appears in the Q3 2018 print edition of The Review. All members, excluding student members, are eligible to receive the quarterly print edition of the magazine. Members can opt in to receive the print edition by logging in to MyCISI, clicking on My account, then clicking the Communications tab and selecting ‘Yes’.

Once you have read the print edition, keep coming back to the digital edition of The Review, which is updated regularly with news, features and comment about the Institute and the financial services sector.

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Published: 08 Oct 2018
  • Opinion
  • The Review
  • Anthony Hilton
  • QE
  • quantitative easing
  • First Person

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