It has undoubtedly been good for ‘risk assets’ such as equities and high yield bonds. US treasury yields have fallen, which in turn has triggered a hunt for yield across all assets. Holders of government bonds have been squeezed out as real yields turn negative.
Within equities, higher yielding, bond like equities have fared well, quite possibly benefitting from the attention of ‘bond tourists’ i.e. those who want steady, yielding assets but can’t get the maths to add up from the lean pickings in the bond markets so find themselves hunting for income in the equity markets.
Performance of indices since 1 Jan 2008
Source: FE Analytics
Companies have been able to take advantage of cheap money as corporate bond yields have fallen to very low levels. For instance, Lufthansa, an airline company with fragile profitability that has suffered several strikes so far this year, managed to raise a five-year bond with an eye-wateringly low coupon of just 1.1 per cent. That’s despite an official ‘junk’ rating from Moody’s.
The intention of central bankers is that this cheap money from QE should fuel ‘animal spirits’, and so percolate throughout the economy.
But so far company managements have, in general, been keener to buy back their own stock, rather than engage in expansionary expenditure, like building new facilities or hiring more staff.
This means that the trickle down impact of QE has been negligible. This is one of the reasons that QE has not really helped the man on the street. Job growth is still weak and real wage growth is still negative. Most people are still becoming worse off, albeit at a lower rate than last year.
The biggest tragedy of QE is that governments have not used the air cover that central banks have provided to grapple with structural reform.
In the UK, with all its talk of austerity and despite G7-leading levels of economic growth, the government is still running a substantial budget deficit that will probably come in at 5 per cent of GDP this year.
This means the national debt continues to climb, which in turn will choke back aggregate demand.
The US has seen gridlock in Washington and Europe continues to flounder in massive government debts. Difficult political decisions continue to be kicked down the road.
If this continues, there will be no way out for Europe without sovereign debt write downs, which would be extraordinarily messy. And in Japan, Abe’s ‘third arrow’ has been conspicuous by its absence.
With government debts continuing to spiral, the experiments in money will continue. The US has stopped QE, but Japan has taken up the running and it is probable that the European Central Bank will enter into out-right QE sometime next year.
Germany has so far been against QE, but as deflation deepens in Europe and German exports suffer from the euro strengthening against Asian currencies, the Bundesbank could be expected to have a change of heart.
For equity investors this will likely mean more of the same. Higher yielding equities will continue to be in vogue because yields elsewhere will remain slender by comparison.
In a low growth, over-indebted world, companies that enjoy some underlying structural growth should command premium valuations. Look for companies that can deliver sustainable top line growth and have defendable margins.
This is not necessarily bad news for equity markets but dividend yield will be a key component of overall total returns. And whilst the experiments in money continue, the prudent equity investor should remain relatively defensively positioned.
Eric Moore (pictured on page 1) is manager of the Miton Income fund. The views expressed are those of the fund manager at the time of writing and are subject to change without notice. They are not necessarily the views of Miton and do not constitute investment or tax planning advice.
