“I don’t want to go from Wild Turkey to cold turkey.” So said Richard Fisher, president of the Federal Reserve Bank of Dallas, in reference to quantitative easing.
“I think we ought to dial it back.” Unfortunately, statements from Ben Bernanke have been less straightforward. Clarity of expression is not a prerequisite for central bankers.
One thing, however, is clear: the US Federal Reserve is walking a tightrope. When it first embarked on QE, it was starting something that it did not know how to finish. It now wants to tell the market that QE will end at some point. But no one knows when – perhaps not even the Fed itself. So, if we can not be sure when QE will end, how can we be any more sure what its withdrawal will mean? And what would a spell of cold turkey mean for investors who look to global stockmarkets for an income?
Ending QE on this scale has never been tried before, so it is impossible to predict the impact it will have. But we can consider the market’s reaction to the Fed’s taper talk in the summer to have been a useful rehearsal. The prospect of tapering sent bond yields sharply higher. That, in turn, saw a lot of crowded carry trades – investments that had made a lot of money over the previous three-to-five years – being unwound. It is worth reiterating that QE had not been stopped at this point. And the world was fundamentally no different than it had been before investors began to discuss the ‘t’ word. Yet the mere suggestion of less loose monetary policy was enough to trigger a sell off.
Investors must therefore consider what will happen as bond yields return to more normal levels. And that is not just a matter for the bond market. It also concerns investors who look to the stock market for an income. What should they do? The good news is that the response to the tapering announcement suggested that monetary tightening will see equities outperforming bonds. But it also showed us that flexibility will be vital.
When conditions change, so should your portfolio. After Ben Bernanke hinted that the Fed might look to reduce stimulus, some managers moved quickly to reduce their fund’s exposure to ‘bond proxy’ holdings with high dividend yields and shifted towards cyclical dividend growth. They may have added to US and Asian growth stories and sold telecoms, utilities and Reits. Subsequent returns bore out the wisdom of these changes. If anything, they should have moved even more quickly than we did.
And, just as they must be ready to change their portfolios when stimulus is withdrawn, investors may have to work (even) harder on their stock selection. QE has helped to prop up asset prices over the past five years. As it is withdrawn, simply holding the obvious (and often overpriced) equity-income names may no longer be enough. There will, however, be plenty of less-recognised companies that will continue to offer their shareholders a high and growing income. The trick will be to buy them at the right price.