Speaking last night, the chairman of the Fed said it is likely to "moderate the monthly pace" of quantitative easing if the US economy continues to grow as expected. The central bank will maintain its bond-buying programme at its current $85bn-a-month rate for now, but all things being well, QE is likely to be tapered later on in the year, and will come to a complete halt in 2014.
World markets have fallen on the news, with the FTSE 100 down 2 per cent at the time of writing and the S&P closing 1.39 per cent down yesterday. The UK index is down around 7 per cent over the last month, when rumours of tapering first began.
Sullivan (pictured), co-manager of the £863m CF Miton Special Situations Portfolio, was perplexed at the optimism that had previously been sweeping through markets, and points to the recent sell-off as justification of his view.
"It’s no coincidence that the market slide has coincided with talk of tapering and QE withdrawal – it underlines our central argument that market buoyancy has been built upon a bed of sand," he said.
"Fundamentals remain weak and therefore market valuations lack the support of the economy. Developed markets are rolling over at a fast pace, whilst emerging markets – and notably ASEAN markets – have been hit hardest due to the rating multiples being more susceptible."
Sullivan fears for markets from here on in, believing the recent sell-off could be just the beginning of a more severe correction. Until sustainable economic growth and unemployment numbers significantly improve, he says he finds it difficult to see a bull case for equities.
"As our friends at [economic forecasters] Belkin have coined it, we have lived through Bernanke’s 'great floatation' and now the party is coming to an end – in time, economic commentators may look back on this QE-fuelled junket and perceive it as the greatest mis-selling scandal of all time," he said.
Sullivan and co-manager Martin Gray’s pessimistic view has seen them significantly underperform their sector since the financial crisis. According to FE data, CF Miton Special Sits has returned 7.94 per cent over the last three years, compared with 22.29 per cent from the IMA Flexible Investment sector average.
Performance of fund vs sector over 3yrs
Source: FE Analytics
The team has a significant cash weighting amounting to 30 per cent of AUM and is significantly underweight risk assets. CF Miton Special Sits can have up to 100 per cent in equities, but currently has about a 35 per cent allocation.
Sullivan says he is not upping his risk exposure just yet, believing that the pain is set to continue for some time. In an interview with FE Trustnet last month, he said equity markets at their current level were around 25 per cent overvalued.
"There are plenty of stocks and funds on our subs bench, but few have yet been brought in to play. Our buying will be 'tapered' as the markets move lower," he added.
The manager is also concerned about developments in China, believing that it could be on the verge of its own financial crisis. The knock-on effects of this, he says, could be very serious for investors.
"Commodities are also feeling the heat of a Chinese slowdown as the interbank rate in China signals a firm intention from the new administration to take heat out of their economy," he explained.
"Credit growth post-2008 in China is already of questionable standard, which begs the question, is a Chinese banking crisis the next shoe to drop?"
It is not the first time the CF Miton Special Situations Portfolio has endured a difficult time during a steep market rally.
Gray (pictured) correctly forecasted the dotcom crash and the global financial crisis in 2008, but in both cases was too early.
Although the fund underperformed significantly prior to both crashes, his ability to protect against the downside has more than made up for that over the long-term, as the graph below shows.
Performance of fund vs sector since launch
Source: FE Analytics
FE Alpha Manager Gray has headed up the fund since its launch in 1997, and was joined by Sullivan in June 2008.
The fund of funds requires a minimum investment of £1,000 and has an ongoing charges figure (OCF) of 1.84 per cent.
Many fund managers have expressed surprise at the timing of Bernanke’s comments regarding QE, expecting the announcement to come further down the road.
Trevor Greetham, asset allocation director at Fidelity Worldwide Investment, says the Fed was "tougher" than he expected, but that he believes in the future it will be less aggressive than the market expects.
He does not think US interest rates will go up any time soon, and believes the unwinding of QE will happen a lot more gradually than many anticipate. For this reason, he believes equities are still the place to be for investors.
"[Bernanke] used the familiar central bank driving analogy of easing off on the gas as opposed to hitting the brakes and stressed there would be a considerable length of time between the end of QE and the first rate hike," he said.
"My feeling is still that the Fed will end up tightening later than this all suggests. Lead indicators are weak and the markets will want to force the Fed to take the drop in inflation more seriously, probably via a further large drop in commodity prices."
Greetham says the strength of the US dollar in light of the announcement is a good sign for US equities, but he says he will be decreasing his weighting to other asset classes.
"The most noteworthy thing about the initial market reaction is the strength of the US dollar despite a further drop in risk assets," he said.
"This suggests the counter-intuitive dollar weakness we have seen since Fed tapering was first raised has run its course and was mostly likely a temporary phenomenon related to the selling of dollar-linked assets in the emerging markets."
"In terms of investment strategy, we will stay overweight the US dollar but we are likely to further deepen our underweight positions in bonds and dollar-sensitive commodities including gold, off hard today."
"We are likely to maintain a small overweight position in stocks in aggregate. Investor sentiment was already depressed before the Fed meeting and in the long-run, stocks are much less exposed to the risk of tightening than bonds are."
"We will stay overweight US equities, where we see good fundamentals, while moving further underweight emerging market equities."
He added: "Japan could come out of the current sell-off looking good. Sentiment towards Japan is at a very low ebb but dollar strength should trigger the next wave of yen weakness. We expect Japanese exports to the US to remain strong and there are increasing signs of a pick-up in activity at home."
In an article later on this week, FE Trustnet will look at how the end of QE is likely to impact asset classes.
Greetham heads up a number of multi-asset porfolios at Fidelity, including the low-cost multi-asset allocator range.
