There has been some speculation that capital markets have priced in the ending quantitative easing (QE) by the US Fed. I believe that it is impossible to predict what will happen to the US and global economy, or to global capital markets, as QE is withdrawn. Therefore it is illogical to believe that the effects of tapering QE can be priced in. Since the ending of QE will mean $85 billion less demand for US and global financial assets each month, if its withdrawal is priced in then surely – everything else being equal – we should see the S&P 500 index at more subdued levels? Not at all-time highs, as it has been this week, and on a trailing P/E of 17.9 (as calculated by ThomsonReuters).
Proponents of the argument point to last week’s positive reaction by the US stock market to stronger than expected jobs data, noting that it defied the recent habit of falling on any good economic data which might in turn trigger the ending of QE. At last, they argue, investors are looking beyond the ending of QE and to the increased corporate profits that will come from the economic recovery. Certainly, the US and the global economy are recovering, illustrated recently by another good third quarter earnings season in the US and the October jobs data.
But to argue that the strengthening of one support more than makes up for the collapse of another, quite different support, is sheer guesswork. Furthermore, the bulls should concede that continuing earnings growth at this stage in the US recovery should not be taken for granted. As the labour market tightens, and interest rates rise, wage costs and the cost of capital will increase and hit profit margins. This is illustrated in the recent widespread downward revisions for Q4 earnings on the S&P 500.
The overall uncertainty created by imminent QE tapering is reflected in the monthly survey of fund managers’ holdings, conducted by Bank of America Merrill Lynch. It shows a relatively high average amount of cash being held in portfolios in October at 4.4%. These professional investors clearly don’t believe that the ending of QE is priced in. The Treasury market is perhaps behaving more rationally than the S&P 500 ahead of QE tapering, with 10 year benchmark yield at 2.74%, a full 1.13% above where it stood this time last year.
What about emerging markets?
At first glance, emerging stock markets look better placed. Surely, after a miserable 2013 they can be said to have priced in the tapering of QE? They stand on attractive valuations, whether measured by price to book ratios (which some investors prefer to use for this asset class, and which currently averages at just over 1.5 times), or on more conventional price/ earnings ratios. If only it were so simple. But again, how can we separate and quantify nervousness over the tapering of QE, from the weak growth and earnings downgrades that we have seen throughout the asset class over the last 12 months?
Summary
This is the third QE program from the Fed since October 2008. When the previous programs ended, global stock markets fell as a substantial buyer of financial assets exited. It appears that this time the ending of QE is being delayed until a much stronger economic recovery is in place, which is supportive of equities. But that is about as much as we can say. We cannot assume that stock markets will shrug off the withdrawal of QE, which is what those who argue that it is priced in are implying. I remain overweight US equities in my model multi asset portfolio, aimed at long term investors. But 2014 could be a challenging year for this particular bet.
Over a million people in the private sector could lose historic right to spouse’s benefits
About one million widows of employees in the private sector could lose their historic right to a pension, if a proposal from the Department for Work and Pensions Is adopted. Employers in the private sector currently have to make payments to a retired worker’s surviving spouse, usually worth at least half their full pension, but the DWP revealed a series of recommendations to halt the ‘terminal decline’ of final salary schemes. The obligation to pay spousal benefits would end if the proposals, which could come into force by April, are adopted. The new plans could also force employees to wait longer before they can retire on a full pension as well as see their payments frozen and left at the mercy of inflation.
Pensions minister Steve Webb said the controversial move could make pensions affordable for bosses without a lot of regulations. However, the cost-cutting will come at the expense of workers whose benefits will be watered down dramatically. The DWP report states that employers can continue to offer schemes that include index-linked benefits and survivor rights if they so choose, but it would no longer be a statutory requirement. The proposal, subject to a six-week consultation, will affect only the future rights – any pension already built up will be protected.