Bill Jamieson: Fed opens the floodgates in bid for prosperity
They told us it was coming and we noted it was coming but when it came shares still leapt in surprise.
Confirmation that the European Central Bank would “do whatever it takes” to deal with the sovereign debt crisis and a similar move by the US Federal Reserve to kick-start America’s ailing economy last week sent stock markets soaring.
This could prove a defining week for the West’s financial system, marking as it does the failure of conventional policy responses and the resort to monetary stimulus on an epic scale.
Indeed, not only has the US Fed pledged to purchase $40 billion (about £25bn) of mortgage-backed securities per month, but to do so until it sees a “substantial” improvement in the labour market. In other words, a month or two of encouraging figures will not be enough.
And the reaction of markets? “We’ll fret about inflation later, but let’s enjoy the sugar rush while it lasts” sums up the mood. On Wall Street, the S&P 500 climbed to levels not seen in nearly five years. In London, the FTSE 100 climbed 2.1 per cent on the week to close at 5,915.6, the highest point in six months. Elsewhere, the Eurofirst 300 Index climbed 1.2 per cent to hit a 14-month high, while in Japan the Nikkei 225 leapt 3.2 per cent.
What makes these latest resorts to monetary easing different from previous announcements is their open-ended nature. The Fed means to keep on buying until after the economy has shown a pick-up. And the ECB is now committed to unlimited buying of shorter-dated eurozone government bonds – albeit under strict conditions – to ease funding pressures on countries that had asked for help.
Playing poker with inflation? Of course it is. Last week’s pronouncements mark the final rout of the central bank anti-inflationists. Back in the 1970s when inflation hit a peak annual rate of 24 per cent and monetarist analysis swept all before it, we wondered at the crass stupidity of politicians and finance ministers who had allowed the money supply to expand so recklessly. How could they have gained support for it?
Now we know. After four years of recession economics in the wake of the banking crisis, monetary expansion is the last weapon to hand. Central banks have been driven to open the floodgates because conventional policy measures have failed and because the prospect of high and rising unemployment is not acceptable in liberal democracies. Monetary purity has to give way to social reality, or so the argument goes.
For investors who have been trapped in poor performing unit and investment trusts, it’s “Get Out of Jail” time. With the Bank of England more likely than not to approve further quantitative easing before the end of the year, I do see the Footsie clambering above 6,000 and pushing on to heights we have not seen since 2007-08.
We could see further gains in equities and these should be underpinned by improving news on business confidence and new order surveys. Green shoots may not yet be visible. But looking at the latest labour market and manufacturing sector data, the ground does appear to be stirring.
For investors this is good news, particularly for those who have unit trust funds or investment trusts biased towards companies paying higher than average dividends. There is no foreseeable risk of the central bank raising interest rates, so higher yielding equities will continue to attract.
This may also be the time to look at specialist smaller company and recovery funds as hopes rise of a recovery finally setting in next year and gathering speed in 2014. But what of inflation? Stock markets have traditionally done well in the initial stages of an inflation take-off. It is impossible to be definitive on when exactly a monetary sugar-rush turns toxic for equities. An inflation rate heading north of 4 per cent would ring alarm bells for me. With inflation currently at 2.6 per cent, and little immediate likelihood of a rise to 4 per cent and over, shares could be set for a strong upward run.
Less easy to predict is how other asset prices might respond. Property assets have traditionally done well in inflationary periods. And looking at the UK housing market, with its sharp fall in new house starts putting a lid on supply, a return to rising prices could be expected. However, mortgage supply is still restricted, both buyers and sellers have little confidence in housing as a store of value, given the past four years, and any sign of a recovery in prices would bring out a wave of sellers. There is a lot of pent-up sales to be worked through before we are likely to see a return to rising property prices.
Equities look set to be the immediate beneficiary. It will be a good opportunity to sell the weak performers as much as to buy. Enjoy the sugar rush for now.
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Weather for Edinburgh
Saturday 25 May 2013
Temperature: 5 C to 17 C
Wind Speed: 13 mph
Wind direction: West
Temperature: 8 C to 17 C
Wind Speed: 14 mph
Wind direction: West