So, with the year of 2013 almost at an end, unless Mr Bernanke decides to raise interest rates this year and sell bonds back to the market (see that pig fly by?!), it looks likely to end up as one of the best years for equity investors in recent times.
Although the FTSE 100 rose by just under 10%, it was positively eclipsed by the 25% rise experienced by the S&P 500 and the 50% tub thumper posted by the Nikkei.
While equities rose, precious metals and related stocks were severely beaten up as inflation (well “official” inflation anyway in the parallel universe that many seem to live in these days..!) remained quiescent and investors continue to anticipate that the Federal Reserve will act sooner rather than later on the QE front. Some even see the program ending totally by mid-2014.
Gold prices tumbled to a 3-year low in June to $1,180 from record highs of almost $1,900 in 2011. With an YTD loss of 26%, it seems that gold will post its first annual decline this new century. It is the same story with silver which has been unable to find support from its industrial applications even as the economy recovers.
Equity investors thus believe en bloc that “Helicopter” Ben Bernanke’s policies are working. Not so fast… An increase in asset prices isn’t and should not be the ultimately goal of monetary policy. The central bank should always put more weight on the economic recovery and on pushing investment and consumption levels higher. Something which QE has failed miserably to do. In effect the “wealth effect” has not spilled over to the wider populace.
All this easing appears to be only pushing asset prices to a point in which they are so out-of-sync with the real economy that when the monetary easing stops investors will likely experience a server hangover. After every party of excess comes a sore head right?
When looking at IMF projections from the World Economic Outlook database we certainly don’t see as many reasons to be bullish as equity investors do given the multiples attached to stocks now. Economic growth has been, and will continue to be, relatively sluggish. Europe, for example, will continue to deliver very low GDP growth over the next few years as a consequence of a massive public and private sector deleveraging. While monetary policy is helping the US government accommodate its huge debt pile and stop the whole edifice from coming crashing down, Europe in contrast continues to reduce its debt levels and which, sadly for the Southern European economies, is translating into a strong Euro – another drag on economic performance.
If at first sight it seems from the table above that the outlook is better for the US, however, when looking more deeply into the numbers, and in particular in looking at recent trends, one realises that there is not actually much that the FED can do other than tweak the current asset purchase program by insignificant amounts.
It is true that the economy is growing at a better pace than Europe but there is no sovereign deleverage program in place and the current debt-to-GDP remains above 100% and will continue to rise for the foreseeable. If the FED stops buying assets, the yield on government debt will almost certainly spike and make it increasingly difficult for the government to issue additional debt let alone repay the existing one. Earlier in the year we already had some clues into this when Bernanke said that tapering would occur this year. Treasury yields spiked, equities had a hiccup and so Mr Bernanke changed his mind…
So, if you ask me do you believe the FED will taper today? I will categorically answer No, I don’t. Firstly, there’s a massive party at the FED for Bernanke and he does not want to spill the champagne. Secondly, as I explained, until the point that the US government decides to tackle the debt problem with fiscal policy, there’s simply nothing the FED can do.
With this in mind, expect Bernanke to play a little with words this evening to give the impression that a taper will eventually occur in the near future. Additionally, Bernanke is scared to death about deflation. The Fed has tweaked the CPI numbers so much during the latest 30 years that the number is about to turn negative and that will give Ms Yellen the perfect excuse to print money when really it is a cover for continued debt monetisation of what is frankly a bankrupt nation!
Filipe R Costa