It was not difficult to notice just how quickly the announcement of a further GBP75 billion of Quantitative Easing (QE) on top of the GBP200 billion already done has already been turned on its head as almost the entire UK banking sector, and some of the commercial property sector, has been downgraded. This means the markets now know that there cannot be any more QE to come.
It would seem that at least someone recognises the fact that if you keep printing money again and again then, eventually, you will bankrupt your own banking system by creating easy money. It is a clear sign to the UK. Basically, the ratings agencies are saying: “This is madness - you have to stop this!”
The probability of this is that it will totally nullify the effect of the QE because people know that there is no more coming down the line.
A similar situation applies to Europe although there is the difference that QE in Europe is seen as a transfer mechanism of liquidity and security from the core nations to The Club Med. However, if anyone does their sums properly, they will see that the EFSF is, at its core level, really only able to fully support Greece and to assist Ireland and Portugal but it is certainly not big enough to deal with Spain and Italy as well.
For one, I absolutely agree with the ratings agencies - especially with S&P downgrading the US credit, even if it did prompt Timothy Geithner to go on TV behaving like a spoilt child who had just seen someone run away with his sweets. Yet they were right then and the agencies are right today and have been right with the downgrades to Greece, Spain, Italy and other European sovereigns and banks. If only they had done this a few years earlier when all the crazy credit was being given AAA ratings then a lot of the worst excesses would have been reined in before. Better than never I suppose and it will be a good thing, longer term, if the ratings agencies rein in the palliative effect of QE by making sure that no more can follow. GBP75 billion, in its own right, is so insignificant in relation to the size of the debt that it will not make any kind of a dent whatsoever.
Martin Gray of MitonOptimal echoed the idea that the UK’s second bout of QE will have a negligible effect on the performance of equities in the coming months.
“There could well be an asset rally maybe in the short-term, but I don’t think we’re going to see a sustained bull run or anything like that... Short-term surges don’t interest me; I’m not a trader, so I’m not going to try and time the market perfectly... I just can’t see how markets can rally, given the poor GDP figures we’re expecting towards the end of the year... Everyone is banging on about how cheap equities are, given that their price-to-earnings ratios are historically cheap. However, I’m not convinced US corporate earnings are going to be any good in the third quarter.”
It’s worth setting these remarks in the context of Martin’s performance relative to that of his peer group:
|Cumulative performance (%)||1m||3m||6m||1y||3ys||5 ys|
|Miton Special Situations Portfolio (B Cls)||1||2||5.6||5.1||33.1||47.3|
|Balanced Managed Sector||-1.6||-10||-8.7||-3.6||20.8||6.4|
While the CF Miton Special Situations Portfolio remains defensively positioned relative to its sector, Gray still sees potential for upside if the markets recover more quickly than he expects - “I’ve added around 10 percent in risk assets this year. I have 15 to 20 percent of the portfolio invested in Asia, which I’m very happy with... In August and September I added to my Asia and Japan weightings. I also wanted to increase my property exposure, but that hasn’t worked out for me yet... I won’t be adding to risk assets unless the markets drop away substantially.”
Miton Special Situations Portfolio has 28 percent of its assets invested in equities - an underweight position of more than 40 percent relative to its sector.
Like me, Martin doubts whether QE will have a positive impact on the economic recovery:
“I really hoped they would come up with something a bit more inspired than buying up more gilts... By doing this, they’re essentially saying banks are in worse shape than they thought. It’s not going to help households with spending, and I don’t think its going to encourage lending or employment either... It’s a bit like giving a patient morphine; the more you give them, the more they are going to need in the long-term... This is potentially very dangerous. As we’ve seen in the Greek bailout, there comes a point when you run out of money... The UK government already owned a big portion of the gilts, but now it must be close to a third of the entire market, including index-linkers. It will be interesting to see if they plan on unwinding their share.”
Whatever they plan they are now at the mercy of the markets. The ratings agencies have made sure of that when they suddenly discovered that they do have a spine after all.
Markets may have rallied but now that we know that there cannot be any more to come, the GBP75 billion will just disappear down the plughole - there one minute and gone the next. It is not going to have a lasting impact and it is not enough to spur a meaningful rally. If people believed in indefinite QE and support and stimulus then maybe there would be a rally until the folly and futility of this becomes evident but, as it is, everyone knows that this is an isolated, meaningless gesture. The ratings agencies have finally pulled the rug from under the central bankers and policy makers. If only they’d done it sooner then maybe QE would not be the Titanic. The problem is that trying to keep everyone in the life they have become accustomed to is just not sustainable. The inevitable consequence to printing money is inflation and, potentially, hyper-inflation and this is the iceberg we are heading straight for.