Those partying with easy money of QE will suffer the hangover
In the current momentum driven market we are on the cusp of partying like its 1999, all the while flirting with the danger that when the music stops the consequences of having bought anywhere near the top are likely to be brutal and swift.
Those partying with easy money of QE will suffer the hangover
By Michael Mackenzie in New York
The equity market rally is putting a disciplined investment approach to the test.
The adage “don’t chase a rally” is a core principle of investing, but such advice counts for little at the moment. As equities advance further into record territory, t he S&P 500 this year has already risen nearly 17 per cent.
After spending much of April unable to break through 1,600, the S&P has mainly been a one-way bet in May, rising towards 1,670 this week.
This is an equity market that rallies most trading days and shrugs aside disappointing economic news with limited price corrections. A case in point was the modest pullback on Thursday after a series of weak data, led by monthly inflation easing the most in four years. That pullback was yet another blip as the market closed at a record high on Friday.
The performance of equities is truly eye opening, and it’s a rally being fuelled by the Federal Reserve’s easy money policy of quantitative easing, all the while downplaying the fundamental and technical basics that ultimately must underpin financial markets.
An uneven recovery in the economy and modest sales growth at the corporate level are being brushed aside for now by the power of central bank liquidity. The equity rally has also occurred without significant fund flows into the market that would confirm investors are back in a big way, let alone justify the big rise in prices since January.
All of which places both private and professional investors in a quandary, particularly for those that have missed the rally so far and have spare cash earning next to nothing.
At this juncture do you chase the rally and place your faith in not fighting the central bank? For history buffs, the S&P is currently tracking very closely its performance from 1995, a year when the benchmark ultimately rose 34 per cent.
Or as an investor do you hold fast and refuse to jump into a market that has risen more than 20 per cent from its low of last November without a significant correction?
Investors, whose portfolios are lagging behind the S&P and possibly face the loss of clients, may throw in the towel and help drive equity prices higher in the coming weeks.
A common refrain of late among investors has been to rue not stepping into a market that back in February briefly dropped 2.8 per cent below 1,500 and then eased 3.3 per cent over several days in mid-April below 1,550, before moving onwards and upwards.
The gnawing fear now is that waiting for a sizeable equity correction against the backdrop of QE3 is a forlorn hope. Investors, whose portfolios are lagging behind the S&P and possibly face the loss of clients, may throw in the towel and help drive equity prices higher in the coming weeks.
This is how momentum trades, as seen with Apple and gold in recent years, really get going, as the fear of losing money is eclipsed by the greed of missing out.
But the Fed’s open-ended suppression of interest rates does trouble some notable equity bulls.
This week, David Tepper, the hedge fund manager who back in September 2010 was stridently bullish on equities as the Fed unleashed QE2, told CNBC that the rally still had legs, but he also issued a warning that the market was in danger of overheating unless the central bank pared its support.
“There better be a true taper, or else you’re back to the second half of ’99,” he said citing the planned additional $500bn in Fed purchases against net debt issuance by the Treasury of $100bn by the end of the year. For Mr Tepper, that $400bn difference could flow into stocks and repeat the last vestiges of the equity bubble in 1999.
“It’s a backwards argument,” he said. “To keep the markets going up at a steady pace the Fed has to taper back.”
The problem with stepping back from the QE pedal is that it would focus attention on a sub-par performance for the economy that is hardly growing at a pace to justify the current equity market rally. Ultimately, easy money is the driver of the equity rally, and for investors contemplating their next move it really all comes down to the Fed.
In the current momentum driven market we are on the cusp of partying like its 1999, all the while flirting with the danger that when the music stops the consequences of having bought anywhere near the top are likely to be brutal and swift.
michael.mackenzie@ft.com |
