Though markets will continued to be supported for the time being – albeit at a slower pace – numerous asset classes are going to have to adjust to life without an abundance of liquidity, which has been deployed every time the strength of the recovery has been called into question.
The initial reaction was inevitably red screens across the trading floors. The S&P fell 1 per cent late in late trading on Wednesday, and a further 2.5 per cent yesterday. The knock-on effects were felt by the FTSE 100 and Nikkei 225 as well, though they’ve rebounded strongly today. It will be interesting to see how the US markets fare when trading opens a little later on today.
All this is very short-term for the majority of investors, given that most are investing on a five, 10 and even 20 year basis. Moreover, as FE Alpha Manager James Henderson pointed out earlier today, there’s no point worrying about what way the markets will turn next, because it’s almost impossible to foresee what will happen down the line. He, along with other bottom-up stockpickers, is much more comfortable concentrating on more predictable company fundamentals.
However, there’s no doubt that the end of QE is a turning point for markets. “A game-changer”, as many industry commentators have called it. Quantitative easing has been one of the principle factors that have impacted asset class performance since 2008, and so when the taps are turned off, something’s got to give.
With this in mind, we asked a selection of investment managers to forecast how the end of QE is likely to impact the likes of equities, bonds, commodities and so on, and how they’re preparing themselves for the changes.
Initially, FE Alpha Manager David Coombs says investors should prepare themselves for a great deal of volatility.
“Initially, the tapering is going to produce an unusual correlation effect on pretty much every asset class, which we saw yesterday,” he said. “Bonds, equities, commodities – everything sold off yesterday.”
“In the short term, I think it’s likely that bond and equity yields will rise –meaning that share prices will fall for the latter.” “At the moment you want to be out of duration in the bond market, and out of equities.”
Coombs (pictured), head of fund of funds at Rathbones and manager of the Rathbone Multi Asset Strategic Growth Portfolio, says he is looking to buy funds that are uncorrelated to both equities and bonds, which he admits is a very hard task.
“We want things that are tactical and nimble,” he said. “Things like the F&C Macro Global Bond fund and Ignis Absolute Return Government Bond.”
Both funds have a low correlation to both the FTSE All Share and FTSE Government All Stocks index over the past year, according to FE data.
Correlation of funds and indices
| Name | FTSE All Share | FTSE Government All Stocks |
| F&C Global Macro Bond | 0.73 | -0.88 |
| Ignis Absolute Return Government Bond | -0.57 | -0.06 |
Source: FE Analytics
Coombs says he doesn’t know how long the high correlation of the asset classes will occur, and will have to react to economic data that comes out in the next few months of so.
“It could be a week, it could be three months,” he said. “We’re going to have to digest all the data that comes out and see where we are.”
One thing is for sure – Coombs is a lot more optimistic about equities than bonds going forwards, and sees that weakness in the former could present attractive entry points for savvy investors.
“The markets fell, but essentially yesterday was a good news story – the Fed are turning the taps off because the US is recovering, which is good for equities down the road,” he said.
“The falls could be seen as a buying opportunity on a selective basis. I think it’s not really going to be a beta play from here, because you’ve got to look for the companies that are beneficiaries of a stronger economy.”
Coombs thinks companies that don’t rely too heavily on debt will be high in demand, because they won’t be impacted by an inevitable rise in borrowing rates. He’s also positive on banks, which should benefits from higher loan and mortgage rates.
Trevor Greetham (pictured), head of asset allocation and multi-asset portfolios at Fidelity, is extremely negative on bonds. Like Coombs, he believes the news should be taken a positive for equities in the medium to long-term.
“Since the financial crisis, QE has propped up commodities, equities and bonds, and the fear now is that trend will reverse without it,” he said. “However, it’s important to remember that QE is being stopped because there is a sustainable recovery going on in the US. This tells me that I’d much rather be in equities than bonds because the US has successfully grown itself out of debt. As such, the yields of US Treasuries are artificially low, and need to correct.”
“I think a lot of money is going to be lost in the government bond market, especially in the US.”
Greetham is particularly optimistic about US equities and Japanese equities, which he believes are set to benefit from the recovery in the US, and a stronger dollar. However, he’s less keen on emerging markets, which tend to do badly when the dollar is strong, and commodities.
“Japan makes the cars and the gadgets for the recovering US consumer,” he explained. “A stronger dollar is what Japan wants as it means a weaker yen. I think a lot of money is going to be made in Japan.”
He thinks investors would be much better off sitting in cash rather than bonds at this point.
“Relative to our benchmark, we have a big overweight in cash,” he said. “If you look at performance in the last month ago, cash has been the big outperformer.”
“It gives you a lot of flexibility and helps to dampen volatility. We’re not in a major hurry to build up our equity exposure at the moment because we think there will be volatility, so it’s a good asset to be in,” he added.
Neil Veicht (pictured), who heads up the SVM UK Opportunities fund, says investors should expect inflated asset classes will now find “a new equilibrium”, which is bad news for bonds.
He too expects volatility across most asset classes in the short-term and has increased his cash position as a result. It currently stands at 15 per cent in his UK fund. “The Fed has responded in this way because they feel the downside risks have lowered,” he explained.
“It would be naïve to think there won’t be negative implications in the short-term, but I can still see equities grinding higher towards the end of the year.”
On bonds, he said: “I think you’d struggle to find anyone who doesn’t think the bond market is over-valued. The question is, where do they settle? In a low growth world there is still a right price. Whether that’s 2.5 per cent or 3 per cent for US Treasuries, I’m not sure.”
All three managers agree on one thing overwhelmingly – yesterday’s news is no good for gold, as its attractiveness as an inflation/currency hedge is losing its sparkle.
"You can’t rule out geo-political issues supporting gold, and something like Syria is worth keeping an eye on," said Greetham.
"However, with the US dollar as strong as it is and QE coming to an end, I don’t think you’re likely to see it hit $1,900 in our lifetime. It’s over."
Veitch added: "If you’re talking about QE resulting in a normalisation of inflated asset prices, not necessarily to absolute levels, but towards 2008 levels when gold was $800 – then things don’t look good.”
"Gold has little intrinsic value – it’s only worth what people are willing to pay for it, which is very dangerous when sentiment is this low."
Coombs says he hasn’t held gold for some time, because he saw the possible end of QE as a big risk to its progress.
Performance of indices over 10yrs
Source: FE Analytics
The Gold price fell more than 5 per cent yesterday, and is currently at $1,294 – well off its peak at $1,920 in September 2011.