Quantitative tightening – what might it mean?

Shrinking central bank balance sheets could undermine record asset prices
The Green Line
Alexander Chartres
Investment Director

Quantitative easing (QE) is one of a raft of ‘emergency’ central bank responses to the Great Financial Crisis (GFC).

By boosting asset prices and cutting borrowing costs, central banks hoped to prevent an economic depression.

$15 trillion of QE-fuelled asset purchases later, global central banks, led by America’s Federal Reserve, are beginning to unwind this unprecedented stimulus.

As the chart above illustrates, central banks will shortly become net sellers of assets for the first time since 2009.

This month’s Green Line asks: how will markets respond to this reversal?

Economists cannot agree on how – or even if – QE works. It seems clear, however, that years of cheap credit and plentiful liquidity have been a boon for Wall Street, far more so than for Main Street.

To the end of last year, for example, US nominal GDP had expanded by 37% since 2009; the S&P 500 meanwhile, returned c 380% from its 2009 trough, with dividends reinvested.1

Financial assets derive their value from a range of factors. Corporate earnings, valuation levels, investor sentiment and liquidity all help determine stock prices. QE has supported them all.

So if QE has had beneficial effects for investors thus far, will its reversal mean the opposite?

Global growth has reached pre-GFC highs and the Fed is betting that positive economic tailwinds will allow them to return monetary policy to normal without overturning the apple cart.

At Ruffer, we believe timing inflection points is impossible, preferring to run an ‘all-weather’ portfolio. If the party continues without the QE punch bowl, our equities will benefit. If the party stops, our protective positions in options, gold, currencies and bonds should prove their worth.

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  1. Ruffer LLP, Bloomberg and US Bureau of Economic Analysis

Chart source: Absolute Strategy Research, Thomson Reuters Datastream

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