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Unsurprisingly, the most common subject for
discussion with investors was QE.
How big is it likely to be? The consensus among
investors seems to be that the Fed will announce
next Wednesday around USD500-750bn to be
spread over a period of months. HSBC’s US
economist, Kevin Logan, sees three possibilities:
a pre-commitment to USD500bn or more, a
contingent commitment to USD100bn per month,
or a disappointment with either no commitment or
only USD50bn a month (see Getting Ready for
Quantitative Easing, 25 October).
Whichever, it seems there is room for
disappointment. Given how high expectations in
the equity market are, can the Fed really announce
something that will impart shock and awe to the
market? It is also likely that journalists and
economists will publish reports questioning how
effective QE will be. From our conversations with
investors, there is much confusion about what the
Fed’s goal is: one asked us how QE can possibly
create jobs. (Our answer to that is that it can’t
directly, but that the Fed wants to at least reduce
the risk of deflation.)
So is it right to take profits ahead of next
Wednesday’s announcement? That is the obvious
reaction: all equity investors know it is better to
travel than to arrive. But this view is so
widespread, we wonder whether it isn’t already
the consensus. And the Fed is not stupid: it
understands this psychology too. The key will be
in its communication, and we would expect some
wording to the effect that, notwithstanding what is
announced this time, the Fed stands ready to inject
more liquidity into the economy if the pace of
growth requires it.
And other factors suggest that, short term, equity
buying could continue. The US earnings season is
at its height, with the fourth successive quarter of
huge upside surprise (almost 90% of companies
have beaten forecasts at the EPS level).
Seasonally, November and December tend to be
the strongest time of the year, with funds
anticipating new money flows in the New Year.
The rush into emerging markets continues (of
which, more below). And we sensed, talking to
investors, that there is still a pain trade from
investors who missed the summer rally (“our inhouse
strategist still thought in July the world was
about to end,” said one). Multi-asset funds, for
example, seem still to be very long bonds.
So, while there may be a period of consolidation
around the QE announcement, we would not
advise significantly reducing exposure to equity
markets. The key arguments we made in our
Quarterly (see Equity Insights: Investing in the
new normal, 4 October) – valuations are cheap,
developed company earnings will decouple from
economic growth, and the Fed is offering a put
option – all still seem valid.
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