The mere mention by the US Federal Reserve of intention to scale back quantitative easing (QE) – never mind the process of actually reversing it – may be enough to spark a sell-off in assets and price falls.
Kevin Lings, chief economist at Stanlib Asset Management explains that, because QE has never before been done on this scale, there is no roadmap out. “It is likely the unintended consequences are not understood, but even more so that they are probably underestimated.”
Most asset prices (including South African and offshore equities) are currently inflated because of low interest rates and the additional QE liquidity. However, Lings says it’s far from certain prices will fall, though it’s inevitable there will be a panic response, overselling and a consequent buying opportunity.
“This is usual in investment markets,” he explains. “To avoid panic selling would require markets to be calm and rational — something we rarely see. The hope is that QE will be gradually phased out in a manner which does no lasting harm, and that by the time it’s actually reversed the global economy will be on such a sound footing that growth will have caught up with valuations.”
So how should investors view the impending return of volatility?
Lings lists types of investor approaches to QE. “There are those long-term investors who will simply ride it out. Secondly, there are those who, while wise to the risk that it’s an accident waiting to happen, have got sucked in because QE has been going on and on for some years and they feel they cannot afford not to be in the market.
“A third category is those who are not committed to the long-term prospects of the market but are just going for the ride rather nervously.
“Each of these latter two groups, starting with the third and then second, will exit the market at different signals — the spark for the third group selling off being the first sign not just of stopping or reversing QE, but as soon as the US Fed makes such an announcement. In reality, it may be years before QE actually gets reversed.
“I would expect this sell-off to mostly hit the bond market, but the investor community will ultimately have to decide on appropriate pricing of each asset in a non-QE environment, for this will decide the point at which other groups of investors decide the market offers realistic valuations and buy back in.
“I believe the Fed will be in no rush to reverse QE, as it can comfortably hold the QE issuance until maturity date. I feel that may be the scenario that comes to pass,” adds Lings.
Nonetheless, we can safely assume that in the unlikely event of a rapid reversal of QE, markets including the Johannesburg Stock Exchange may come under significant pressure, and commodity prices would plunge along with the rand.