Stepping Aboard The QE2

09.11.10

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After much speculation it came as no surprise when the US Federal Reserve Bank (Fed) announced that it was embarking on a second round of quantitative easing. The news came the day after the Demo

After much speculation it came as no surprise when the US Federal Reserve Bank (Fed) announced that it was embarking on a second round of quantitative easing. The news came the day after the Democrats lost control of the House of Representatives and both these events should be positive for the stockmarkets. Just the prospect of QE2 had helped stoke the rally that extended from September through October.

QE2

The Fed announced its QE2 (as it?s commonly called) on 3rd November. It will pump an extra $600 billion ($100bn more than expected) into the economy. By the end of next June it will have bought $850-$900 billion of treasuries ? around $110 billion a month, of which $75 billion will be additional QE.

The aim is to boost the economy and tackle the 9.6% unemployment rate. The move should also drive investors to equities and corporate bonds as they look for higher returns. Indeed, encouraged by the fact that the world?s biggest economy should now start to improve, investors bought shares and stockmarkets rose around the world.

In a statement the Federal Open Market Committee said it was acting to kick start a ?disappointingly slow? recovery. It will adjust the programme as needed to best foster maximum employment and price stability.

Writing in the Washington Post the following day, Chairman Ben Bernanke said that the programme should help the Committee meet its obligations to promote increased employment and sustain price stability.

He wrote: ?This approach eased financial conditions in the past and, so far, looks to be effective again. Stock prices rose and long-term interest rates fell when investors began to anticipate the most recent action. Easier financial conditions will promote economic growth. For example, lower mortgage rates will make housing more affordable and allow more homeowners to refinance. Lower corporate bond rates will encourage investment. And higher stock prices will boost consumer wealth and help increase confidence, which can also spur spending. Increased spending will lead to higher incomes and profits that, in a virtuous circle, will further support economic expansion.?

US mid term elections

President Obama?s Democratic party lost control of the House of Representatives, with the Republicans also gaining more power in the Senate. While one may think this could lead to uncertainty and a political gridlock, it is not an unusual situation after the mid-terms and the results are actually considered good news for shares.

Political balance stops a party passing laws unilaterally, which can be bad for business. The Republicans now can potentially force policies which are more supportive of the companies that need to create the missing jobs.

Historically the situation is very encouraging for US equities. Out of the last 19 midterm cycles, the S&P 500 has produced positive returns 18 times. It returned an average 13% over the six months following the mid-terms and then 17% over the next twelve months.

On previous occasions with a Democratic president and Republican legislature, the index averaged 14.6% annual returns over the following year. Judging by history, therefore, the current situation has every possibility of being a positive one for US stockmarkets.

There has been further encouraging news from the US. Its gross domestic product achieved 2% annual growth in the third quarter of the year, up from 1.7%. Consumer spending climbed 2.6%, its strongest rate since 2006. The services sector and private-sector jobs growth were also stronger than expected.

The UK

While less certain than in the US, there has also been much speculation that the Bank of England (BoE) will also embark on its version of QE2. At its meeting on 4th November the Monetary Policy Committee appears to have taken a ?wait and see? approach and did not follow the US by announcing similar measures ? a decision no doubt influenced by the better than expected third quarter growth and above-target inflation.

However this may just delay QE2 and many economists expect it to be launched in February. Roger Bootle of Capital Economics explained: “Further support is needed to see the economy through the biggest government spending cuts in decades, with extra asset purchases the only option left.? Chancellor George Osborne also admitted that further QE was a possibility.

Investors

UK shares may benefit from the anticipation of QE2, as happened in the US, and are also enjoying a rally on the back of the US QE2 announcement. On 4th November the FTSE 100 climbed to its highest level in two and a half years.

While many investors will be feeling rather content right now, savers have been warned that they are unlikely to enjoy better interest rates any time soon. The fact that QE is on the cards means that the BoE will probably keep rates low for the foreseeable future.

Of course quantitative easing is a remedy for disappointingly slow growth, so the news is not entirely good and markets could fluctuate between economic growth concerns and the excitement of further monetary policy measures. Overall, though, I think there is every likelihood that the autumn stockmarket rally will continue through to the end of the year.

Quantitative easing reduces the value of the country?s currency against that of its trading partners with healthier finances. This adds to the attractiveness of its exports, helping local business improve profit margins. And even if growth remains subdued at home, both the US and UK large cap sectors are global in nature and so are positioned to benefit from the general improvement in global economies, particularly the expanding economies of developing markets.

Your equity portfolio would normally include shares or funds covering different regions, with the quantities dependant on your risk tolerance, objectives and personal circumstances. Talk to an experienced wealth manager like Blevins Franks Financial Management Ltd to establish the allocation most suitable for you.

By Bill Blevins, Managing Director, Blevins Franks

5th November 2010

Tax rates, scope and reliefs may change. Any statements concerning taxation are based upon our understanding of current taxation laws and practices which are subject to change. Tax information has been summarised; individuals should seek personalised advice.

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