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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.

Why traditional safe havens might not work
April 2018: In the market sell-off this February, defensive assets failed to defend.
Read
Japan: a forgotten market?
March 2018: Japanese shares have risen strongly, but not nearly as much as company profits.
Read
Misplaced confidence?
February 2018: US consumer confidence is very high. Our analysis suggests this is not good news for investors in equity markets.
Read
  1. Ruffer LLP, Bloomberg and US Bureau of Economic Analysis

Chart source: Absolute Strategy Research, Thomson Reuters Datastream

our thinking
Inflation: bad for portfolios, good for society?
As inflation has soared to its highest level for 40 years, financial markets have taken fright, with most bond and equity markets down significantly so far in 2022. In fact, the US is now officially in a bear market, and inflation pressures show few signs of fading – quite the contrary.
Swimming naked
July 2022: It is hard to overstate how far free and unlimited central bank liquidity has rewired the financial system. As central bankers extract themselves from the monetary rabbit hole they have burrowed their way into, the damage to traditional portfolios is likely to be considerable. This tightening of monetary policy is happening because inflation has returned – with a vengeance.
Ruffer round up – Q2 2022
July 2022: Investment Director Duncan MacInnes joins Rory McIvor for a review of the quarter, discussing the scale of wealth destruction across markets and how they see this rippling out into real world behaviour, and looking forward to what could be on the horizon and what that means for investors.
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Investment Review
July 2022: Jonathan Ruffer explains why wage demands are the final element required to fuel the new inflationary epoch. This regime will be good for social mobility in the long run, with the workforce and innovators as the winners. But it might well be brutal for the investment community.
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OUR THINKING
London
80 Victoria Street
London SW1E 5JL
Edinburgh
31 Charlotte Square
Edinburgh EH2 4ET
Paris
103 boulevard Haussmann
75008 Paris, France