THE QE PARTY IS OVER

There is no doubt that in the past decade we have witnessed some of the most incredible growth in equity prices that we have ever seen over any 10-year period. In fact, the UK benchmark stock market, the FTSE100, took just 6 years to double in value from its lows at around 3,500 in March 2009 to just under 7,000 in March 2015 – that’s a whopping 16% annualised return and PLUS you earn your dividends on top! Imagine that. At a time when the Bank of England Base rate was floored at 0.5%, the lowest level in its 320+ years of history, and when most current account holders were lucky to be seeing 0.1% interest on their savings, it is incredible to now consider that investing in equities could have been so lucrative. In fact, to give you some perspective, it would have taken current account holders 1,000 years to earn what equity holders earned in just 6 years. Wow. So, the question then becomes why such a differential? Sure, the stock market was low and we had just come out of the worst financial recession in almost a hundred years, so of course one might expect a strong recovery. And yes, because interest rates were so low, the stock market undoubtedly benefited by default as investors flocked for better returns that could at least match an inflation rate of 2-3%. One could even argue that the return on equities needs to be higher than cash to represent the higher risk involved. Whilst there is an element of truth in all of these statements, none of them can explain why equity investments didn’t just beat cash investments but absolutely annihilated them, so there must be something else. Let me tell you what I think it is – it’s intervention or what I like to call UI (Unhelpful Intervention). As human beings, we have this terrible trait to think that we know best. This means that when things are not going quite how we want them to be, we interfere in the process to try to make them fit our vision. This is exactly what happened with the stock market. It doesn’t matter that the only reason that the stock market works is because it allows buyers and sellers to come together to decide on what is a fair price by the basic universal laws of demand and supply. It doesn’t matter that the single most important building block upon which all stock markets are founded is efficiency and that any artificial influence, no matter how well-intentioned, undermines that. It doesn’t even matter that external intervention can destroy certainty and bring unknowns to investors which cannot be quantified thereby significantly increasing longer term volatility and risk. No, unfortunately dear readers, none of this actually matters. What matters is that some people in high-powered positions wearing dull suits and haircuts to match, find it necessary to interfere. I don’t know whether they do so because they genuinely feel that they are helping or because they need to justify their eye-watering salaries as the heads of the major Central Banks around the world. Whatever the case there are only 3 words to describe it; Wrong, Wrong, Wrong. This unhelpful intervention that I talk so disparagingly about is of course Quantitative Easing (QE). Most investors will recognise QE as money being injected into the economy to boost spending and growth, and could be forgiven for thinking that perhaps this is not such a bad thing after all. Unfortunately, they would be misinformed. If the objective was for the global stock markets to recover faster and grow stronger than ever before then there is no doubt that QE has been a huge success. Stock market indices have broken all records surpassing everybody’s expectations. But if the objective was not for massive, uncontrollable gains but rather for steady, certain growth underpinned by genuine corporate valuations, then it has failed miserably. Most of us just don’t know it yet. There is no doubt that the UK, US, Europe and the Far Eastern markets have benefited from the financial excesses awarded through QE. For example, the UK injected £400 billion of money (that it never previously had) into the economy between 2009 and 2012, and then an extra £60 billion more recently for Brexit just for good measure. The US Federal Reserve, between 2008 and 2015, printed dollar notes through the purchase of bond securities worth just shy of $4 trillion! And as to our European friends, unbelievably they are still printing, at least for now. After years and so many rounds of cash injections that we have had to assign them separate names, (QE1, QE2, QE3), we are now fast approaching a period where the magic cash pot has run empty and the printing machines for the first time since the financial crash are become eerily quiet. The problem is that there is no turning the clock back. Just like it’s not easy to appreciate the damage that a body builder is doing to his body when he is pumping himself up with steroids, so too is not easy to tell how much damage has been caused by QE. What I am sure of however is this. The party is over. However, because QE appears to have been hugely successful most analysts and commentators are fearful to bad-mouth a strategy that seems (on the surface at least) to have done fantastically well and has transformed the lives of millions around the world. So, allow me to help them. It was a huge mistake. I understand the reasoning and the logic behind it and I get it – really, I do. But that doesn’t mean that it’s right. This is sadly one of those cases where the end doesn’t justify the means. That’s because most people have not been paying full attention due to being absorbed in their own riches, and so have missed things going on around them. For example, consider those companies, particularly within the emerging markets that have borrowed heavily in recent years because of low interest rates and have taken investment decisions based on a false economy. They over-leveraged and took investment decisions on the understanding that interest rates would remain low and the money supply tap would remain open. Unfortunately for them that’s all changing. Interest rates are now heading north and the well that used to feed the money tap has run dry. This is going to squeeze those companies which enjoyed the excesses but didn’t make plans for the tidying up afterwards. Thankfully not all businesses have operated so recklessly but many did, more than we know, and now I expect the market to ruthlessly hunt them down and hang them out to dry. With the meddling hands of Central bankers severely limited in what they can now do, both from an economic and political standpoint, we will see real market forces back in action for the first time since the 2007-8 financial crisis and it will be interesting to see who stays standing. Like all great parties there is a price to pay in the morning after and I predict that for some this will be the mother of all hangovers.