We are at an important juncture in the current bull market. The usual drivers of share price escalation are, to a large extent, spent forces. The initial booster — declining interest rates — has been jettisoned. Indeed, the commodity price impact of a weaker dollar and the overlay of oil price uncertainty as a result of the populist revolts in the Middle East and North African countries imply a pick-up in general inflationary pressure.
Several of the growth powerhouses (more specifically Brazil, India, Australia and China) have started to hike rates in order to slow things down. The additional, non-traditional measures — dubbed quantitative easing (QE) — are not likely to be renewed. Given the positive share market impact that QEI and QEII had in the US and elsewhere, investors are right to be concerned. The graphs show the performances of the S&P500 and the JSE All Share in US$-terms pre- and post the introduction of the QEs (the red arrows mark the announcement).
It can be argued that the first one in November 2008 was more critically timed. The S&P500 had been in freefall (-51%) since 2007 and the JSE was off by over 60% over the same period. Subsequent to the announcement of QEI, equity markets staged a significant recovery, interrupted only by the travails of the peripheral European economies early in 2009.
Diversify with a spread of assets
At the launching of QEI, the US Federal Reserve held about $750 billion of Treasury notes on its balance sheet. By June 2010, this has ballooned to $2,1 trillion in bank debt, Mortgage Backed Securities and Treasury notes. After a brief pause, the Fed decided to renew quantitative easing in August 2010 because the economy wasn’t growing as desired and targeted the buying of an additional $600 billion of Treasury securities by the end of the second quarter of 2011.
For the best part of eight months — until the announcement of QEII — share markets tracked sideways. Given the correlation between positive share price moves and the imposition of QE strategies, investors are holding their collective breaths at what might happen come June 2011. Critically, the Chairman of the Federal Reserve, Dr Ben Bernanke, recently indicated that the end of QEII should not be seen as a resumption of monetary tightening, implying that the super low level of rates will continue into the foreseeable future. In the short-term, US economic activity and inflation levels are at levels that do not justify any further stimulatory measures. Nevertheless, no QEIII does signify a change in policy which is likely to bring indigestion to financial markets.
On the whole, as an investor, expect uncertainty and volatility in the equity markets during a period of the year that traditionally reflects these characteristics anyway, and ensure that your portfolio is well diversified, with a spread of assets in order to limit any downside in share portfolios.