13 SEPTEMBER 2013
All Good Things Must Come To An End And So Will The Bad
By Gabriel Gan
There are a few reasons to be singing Auld Lang Syne – a song sung as a farewell or an ending to other occasions because after so many years of involvement with Shares Investment, this will be my final contribution to this publication that I first joined as a Research Analyst in May 2000. I have not stopped writing even though I left in 2006 to pursue another career and I am grateful to the management for giving me the opportunity to write.
The other reason to sing a farewell song after romancing it for so many years is that of an end to quantitative easing. All good things, or is it, must come to an end because too much of a good thing can do more harm than good. It is only a matter of time before the US Federal Reserve (Fed) does so – be it Ben Bernanke or his successor, as hinted by the Chairman himself and echoed by his fellow members of the committee, or the US economy may face runaway debt level and, ultimately, uncontrollable inflation.
The unconventional way of treating the financial crisis that struck in 2008 must be credited to Ben Bernanke who will probably go down in history as one of the best, if not the best, Fed Chairman in American history. He not only dragged the world out of a great recession, he can also be credited with taking the US back on the growth path albeit a weak one at this point in time.
His critics, however, have always been quick to bring out the knife by arguing that Ben Bernanke’s policies have done little to help the real economy but has instead helped to fuel rising asset prices without building a firm foundation for the economy. This, they say, is throwing more and more good money after bad ones and such moves will hurt the US economy in the long run as wealth created by an artificial inflation of assets will only create asset bubbles that will burst once the cheap credit is no longer available.
While his detractors do have a point, Ben Bernanke must be hoping that the best he could do back then, which is to turn on the printing machines, will encourage borrowing, boost consumption, create the wealth effect and lift the economy before worrying about life after quantitative easing.
What else could he do? Were there other alternatives back then? Can the US allow its major companies to go bankrupt, allow the entire economy to fall into another Great Depression before letting the economy recover by itself?
The Most Watched FOMC Meeting
Come 17 to 18 September, nobody making a living in the financial market will turn off the television – not even those in Asia although the decision will probably be announced only at 2 a.m. Singapore time. Investors will want to know what are the decisions the Fed will make as well as what the Fed thinks is the fate of quantitative easing going forward.
Since most investors now expect the Fed to taper at the forthcoming meeting, the Fed will most likely take the opportunity to taper by about US$10 billion to US$15 billion from the original amount of US$85 billion of bond buyback programme each month.
On the part of investors, we should all learn to live with life without quantitative easing because it will end. We have to end this addiction whether we like it or not. Now that there are signs that we are slowly getting used to the idea of a gradual reduction in quantitative easing, it is the best time for the Fed to trim by what the market expects, no more and no less. This is because financial markets will not react violently should the Fed take the first step towards its exit but more importantly, the Fed must watch even more carefully what it says after announcing its reduction because investors want neither a shock nor an uncertainty.
A shock will probably come in the form of a reduction to anything less than US$70 billion a month while saying things like “future Fed decisions will rely on economic data in the forthcoming months” is safe but creates a bit of uncertainty. We have been living with this uncertainty for a couple of months hence the safest thing to say may not really be the best for the markets.
Should the Fed change its statement to something more hawkish, the markets will fall. Anyway, we are all going to be facing this uncertainty about the end of stimulus until it officially ends.
Life After Quantitative Easing
Life after kicking a drug or alcoholic addiction should be easier, right? Wrong!
After the end of quantitative easing, investors will start to fret about when interest rates will rise! Financial markets are full of uncertainties but this is what makes the markets so interesting and volatile.
From a series of rate cuts to quantitative easing to the end of quantitative easing, the cycle will only come to an end when interest rates start to rise. This is unavoidable and is the rule of the game because when the economy picks up, which it is doing right now, inflation will creep in and interest rates have to rise. Emerging markets in Asia have already started to feel the strain of inflation especially India and Indonesia where falling currencies and stock markets are reminiscent of the Asian financial crisis in 1998. China’s recovery is also picking up and there is no way China can avoid rising inflation in the near future hence the rate hike story will come into play not this year but probably next year.
If we put all the pieces together, which is inflation in Asia as well as the US, then next year’s theme will be one where rate hike worries take centre stage after the quantitative easing story is played out. This will only happen in the second half of next year so this is just an early warning to all readers.
Meanwhile, gold prices have fallen by so much since its peak and it may fall even more once the Fed starts to taper. But the second half of next year, or even earlier, will see gold prices rebound once investors start to talk about inflation and rate hikes. Gold has traditionally been a hedging instrument against inflation but a stronger US dollar may have the effect of cancelling out the theme of gold being a hedge for inflation.
Let’s Talk About Something More Recent
Readers may ask, “Who cares about next year?!”
Fine, then we shall talk about next week if the FOMC meeting is really that important. I think it is an important period.
The stock markets have been rising and rising since late August and it is likely that investors are expecting the Fed to do what the markets expect – cut only US$10 billion to US$15 billion a month – hence this is some form of a relief rally after a punishing month in August.
With markets very overbought in the near-term, I will not be surprised to see some “sell on news” when Ben Bernanke announces the decision on 18 September. I do not have a crystal ball, but this is likely to happen because markets cannot rise much further when technical indicators are overbought unless we get a minor three-day correction starting from 13 to 17 September.
I wish all readers of Shares Investment a great year ahead!
Publish date: 13/09/13