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Investors cautioned on QE tapering over-reaction

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With the Federal Reserve suggesting it could start to taper its quantitative easing programme later this year, investors have been cautioned against over-reacting to the news.

The Fed’s $85bn a month bond-buying programme has been credited with keeping markets afloat, so chairman Ben Bernanke sparked panic when he said in May that it would be “appropriate to moderate the monthly pace of purchases later this year” if the US economy continues to grow as expected.

Charles Stanley Direct head of investment research Ben Yearsley says there has been a degree of over-reaction to Bernanke’s comments.

He says: “Everyone knows that gilts and much of the fixed interest market is highly valued at the moment – I deliberately am not using the word overvalued or expensive – and at some point prices have to fall.

“The fact that QE is potentially being tapered means US policymakers believe the recovery is genuine and can survive unaided. QE and unusual monetary stimulus cannot go on indefinitely.”

Yearsley warns few investments will be immune from a big bond sell off when it happens but he stresses the importance of spreading risk. In the bond space, this involves having diversity in terms of sector, credit and maturity.

Bestinvest managing director Jason Hollands says he continues to be wary of fixed income as a result of the mispricing caused by QE. 

He says: “I expect the asset class to remain volatile as investors try and interpret each new piece of data to see whether the assumptions underpinning the Fed’s programme for tapering down its bond-buying programme are being met.

“Despite the spike in spreads long-term government bond yields are still below inflation, so it is too soon to call this shake-out complete.

“Government bonds, index-linked gilts and core investment grade bond funds look particularly susceptible to this process of market reappraisal, while funds with a focus on short-duration positions and high yield bonds are less sensitive though not entirely immune.”

Architas senior investment manager Sheldon MacDonald says the Fed knows it has the power to move markets so its latest statement could be an attempt to stop asset prices running too far ahead of fundamentals.

MacDonald, manager of the Architas Multi-Asset Blended range and the Axa Wealth Elite funds, says it is important for the markets to be reminded that QE cannot continue indefinitely.

QE

He says: “One of the first market wisdoms you are taught as a young analyst or trader is ‘do not fight the Fed’. Reasonable advice given the access it has to information. Investors have clearly been heeding this for some time, enjoying the benefits of rising asset prices, driven by massively expansionary monetary policy.”

MacDonald adds the underlying picture of the US is relatively healthy, with recent consumer confidence, durable goods and home sales levels surprisingly on the positive.

He says: “This helped offset the potential tapering of QE but other negative factors, in particular slowing growth and the credit crunch risk in China, saw investors re-pricing their attitudes to risk in quite dramatic fashion.”

MacDonald says he is not making wholesale changes in his positions. He adds: “As equity markets continued to rise, their relative attraction waned, but we could not see much value in fixed income assets either, so preferred to hold back on deploying inflows into our funds.

“Market volatility creates opportunities, so we will consider asset classes or regions which become undervalued. Holding cash gives us the flexibility to do this quickly if necessary.”

Rathbone Enhanced Growth fund assistant manager Mona Shah says no material changes have been made to Rathbone’s multi-asset funds since Bernanke’s announcement, as concerns over the withdrawal of QE have been around for some time.

She says: “Given the extent to which the market has become sensitised to policy decisions, we have been fearful of a 1994-style flash crash for some time. We therefore implemented put options across all our portfolios to offset this tail risk earlier this year. This meant that we were able to maintain our existing allocation to equities, where there are pockets of value.”

Shah adds the portfolios have remained overweight the US since last year, believing the authorities have acted decisively to drag the economy out of the crisis and stimulate growth. She says the Fed would not have moved down this course without sufficient evidence of economic strengthening.

Shah says the fund has been reducing fixed income exposure over the last year, based on a lack of value, but accepts that US Treasuries remain a safe-haven in investors’ minds over the long term.

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