Life After Easy Money
Warren Buffett once said, “only when the tide goes out do you discover who’s been swimming naked.” That is very much the case now, after the Federal Reserve’s June 19 announcement that it might start scaling back its program of buying up assets from financial institutions–to the tune of $85 billion a month–later this year. The news prompted a roller-coaster ride in the markets. Stocks plummeted, commodities crashed, bond yields jumped and credit tightened as investors began to realize that the low interest rates from this easy-money party could finally come to an end. Some types of assets have since stabilized, but we’re facing a summer of volatility as investors begin to unwind positions they took to benefit from the Fed’s multitrillion-dollar program of quantitative easing (QE). The Fed’s approach successfully buoyed markets and boosted confidence, but it has also created bubbles in areas like emerging markets, commodities and corporate junk bonds.
Dallas Fed president Richard Fisher said as much in a recent interview with the Financial Times, in which he also defended the Fed’s decision against critics who claim that the money spigots were being turned off too soon and that the shock would derail the economy’s recovery. Fisher accused these complaining Wall Streeters of being “feral hogs” and said the Fed can’t prop up markets indefinitely. The question, of course, is whether markets can now stand on their own. The end of QE is a market sea change, the biggest since the financial crisis. “The era in which central bankers are able to impose stability on a still inherently unstable set of global economic and financial fundamentals is coming to an end,” PIMCO CEO Mohamed El-Erian told me. Here are three trends to expect once the dust clears.
Risk looks less attractive. The whole point of QE was to push investors into riskier assets, thereby propping up markets (and, to a certain extent, the economy). The Fed kept interest rates low, which meant investors looked for higher yields wherever they could be found–at times, in dicey places. Commercial real estate and C-grade corporate bonds, for instance, will likely be down for the count. Safer bets like high-dividend-paying, blue-chip multinational stocks will likely spring back. “The end of QE won’t be the end of the world for the stock market,” says Capital Economics chief markets economist John Higgins, but don’t expect the sort of jumps we’ve seen in recent years.
Markets fall out of sync. For the past few decades, there has been a tendency for markets to move in concert: emerging markets would rise and fall together, as would developed nations and various industrial sectors. Things were either up or they were down. Statistics now show that these correlations are breaking down, requiring investors to focus on the stories of individual nations and companies. Europe, for example, is probably going to be in recession or flat for years, while the U.S. shows signs of a stronger recovery. Overhyped developing nations like Brazil and Turkey will be at economic and political risk; others with sounder stories will fare better. Indeed, it may be a good time for investors to start cherry-picking around the world: with the MSCI emerging-markets index down 19% since the beginning of the year and emerging-market stock valuations below their long-term averages, plenty of companies and countries are looking cheap.