In early November the Fed duly delivered, promising a further $600 billion of quantitative easing (widely known as QE2) over the next eight months. They also said they would “adjust the programme as needed to best foster maximum employment and price stability” – so leaving the door wide open for further money printing if needed. It is clear deflation is unlikely while Ben Bernanke chairs the Fed. Meanwhile in the UK, the Conservatives reversed their pre-election policy. George Osborne has said he would not be opposed to the Monetary Policy Committee (MPC) announcing additional quantitative easing. I expect further QE in the US, UK, Japan and even, eventually, in Europe.
The big question is, of course: will it work? No-one knows what effect QE will have.
It is a giant economic experiment. I am firmly of the view that in time, QE will
be inflationary. In the short run though, markets like it, acting as a green light for speculators. But in effect it is a continuation of the disastrous policy of the Greenspan era whereby investors expect to be bailed out if there are problems. This creates moral hazard and is known as the ‘Greenspan put.’
In my view it was policies such as these that were largely responsible for the financial crisis. Bernanke’s policies led the German finance minister, Wolfgang Schaeuble, to declare that “with all due respect, US policy is clueless.” Intuitively the idea we can rack up enormous debts, issue government bonds and then buy them all back with newly created ‘money’ is not a policy one would expect to be successful. Governments have tried these policies before and usually their currency falls and inflation rises. I expect volatile conditions ahead.
Equities and other assets
For two main reasons, I still think equities are cheap. Firstly, companies in general have been remarkably profitable throughout what has been a deep recession. Secondly, there are many high quality companies which still have P/E ratios of 10- 13 times, meaning they have earnings yields of between 7% and 10%.
This compares very favourably to the yields on cash and government bonds. I also believe that although shares offer good value, they will be volatile because the underlying macro-economic conditions are not good. This will not be a traditional ‘buy and hold’ bull market, hence our policy has been one of gently selling shares as they rise and buying them on falls.
On bonds, I continue to believe we are at the end of a multi-year bull market for bonds and expect we will shortly be embarking on a prolonged bear market. In terms of currencies, I expect to maintain for a long time our core position of being long the Asian currencies and short the big four reserve currencies.
Gold? We would rather short government bonds, where the downside risk is low, than have a large position in gold and other commodities where the downside is potentially much higher. Ask an investor why they hold gold and they will probably make the point that governments can’t print gold and it is a protection against currency debasement and inflation. These are also valid reasons for not holding government bonds. It seems improbable to me that the government bond market and gold can both be right.
So although we like gold, we prefer our government bond shorts. We will continue to sell our commodities if prices rise higher.
