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Neil Woodford: QE just makes the asset-rich richer

The ECB’s commitment to roll out QE simply offers false hope to investors.

Neil Woodford Peach

One of the many topics of discussion by the World Economic Forum in recent years has been deepening income inequality. Indeed, it was identified as this year’s most significant trend by the forum’s experts.

It is therefore ironic that, as the world’s policymaking elite met in Davos last month, the European Central Bank introduced a policy that exacerbates inequality, with Germany finally conceding the eurozone’s problems were significant enough to warrant a programme of quantitative easing.

QE is money printing hidden behind a very poor disguise. Central banks create money electronically and with it they buy assets, primarily sovereign bonds. The intention thereafter is that the institutional investors that have sold their sovereign bonds will reinvest in assets a little further up the risk spectrum. This forces the next seller to do the same and so on. Ultimately, the stated purpose of QE is to inflate the price of risk assets in the hope that, in so doing, the benefits of higher asset prices in the financial world will “trickle down” through the economy to provide a boost to activity in the real world.

Unfortunately, we have plentiful evidence from the past six years to confirm the trickle-down effect simply does not work. The fruits of the policy are consumed in the financial world but the wider economy fails to benefit. On its own QE does nothing to improve economic fundamentals.

What it does do is redistribute wealth. It makes the asset-rich richer but the asset poor see no benefit and continue to be more exposed to the economy’s structural problems, such as high and rising youth unemployment, a lack of real wage growth and persistently high debt levels. Hence, we have wealth and income inequality in the western world rising to levels with which policymakers are clearly uncomfortable. Indeed, this unintended consequence of QE in the US was one of the primary reasons the Federal Reserve abandoned it last year.

The ECB’s decision to embark on a QE programme later this year followed months of speculation and eventually arrived against a backdrop of a weak and deteriorating economy. The eurozone already has negative inflation rates and the policy may have been introduced too late to avoid a more prolonged bout of deflation in the region than the brief period of falling prices that we saw in 2009.

Regardless of the fundamentals, however, global stockmarkets have enthusiastically greeted the prospect of QE in Europe. It has become a knee-jerk reaction for risk assets to rally in anticipation of the next liquidity injection. The policy is, after all, designed to lift asset prices and it has succeeded in doing so in the past.

However, as we are all regularly reminded, past performance is not necessarily a guide to the future and there is good reason to believe risk assets may ultimately behave differently this time.

Graph 190215 p20

First, we must consider valuation. When equities were cheap, QE fuelled a re-rating. That story has now played out, however, and stockmarkets generally look much more fully valued. From here, it is more difficult for markets to move materially higher. Indeed, in an environment where earnings are vulnerable to downgrades, global stockmarket indices are pregnant with risk.

Second, there is the Greek situation, which, at the time of writing, remains unresolved and uncertain. Even if negotiations do conclude successfully, it is difficult to see how a compromise can provide a permanent solution to Greece’s problems while keeping the Germans happy at the same time. Europe’s troubles are not just confined to Greece, though, albeit the current stand-off does epitomise well the region’s broader issues. In other words, the eurozone crisis will rumble on with the potential to upset financial markets at any time.

So there are good reasons, in my view, to question the market’s knee-jerk positive reaction to more QE. That is not to say stockmarkets will not continue to move higher – they might but if they do it is likely to be through a further re-rating rather than earnings growth. In turn, this simply brings with it the ultimate risk of an even more significant correction when fundamentals eventually and inevitably reassert themselves.

From a strategy perspective, therefore, the introduction of QE from the ECB does not change the way my portfolios are invested. I remain focused on identifying attractively valued businesses
I believe are capable of delivering long-term returns in spite of all the headwinds. Fortunately, although indices now look vulnerable more broadly, inequality exists in stockmarkets as well as economies. There remain some profoundly attractive investment opportunities.

Neil Woodford is head of investment at Woodford Investment Management

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Comments

There are 5 comments at the moment, we would love to hear your opinion too.

  1. the elephant in the room 23rd February 2015 at 1:40 pm

    Brilliant Neil,

    At last someone from within the city is finally saying what needs to be said. The current status quo needs challenging and how….

    It seems blindingly obvious to me that these so called ‘stimulus measures’ do nothing to help the majority and in real terms we all become worse off. QE is a just another way of taxing the majority for the benefit of the few – and as Mr Woodford points out – ultimately the very few.

    All these bailouts are simply a form of Socialism for the Banks, whilst those on the other side of the wall have to deal with a much harsher version of Capitalism. We have no bailouts, no debt forgiveness, no freshly printed bank notes (or an expansion of computer digits), no no no – as our debts are real, our problems remain and furthermore the money in our pocket is becoming worth less and less every time they do this. Indeed, QE must be the one of the biggest con tricks ever pulled by a government on its own people!

    This is why it is important that a respected city bod like Mr Woodford challenges these arguments – for they need challenging, before we allow the banks and governments to make more of a mess of things than they have already!

    In the words of national treasure Johnny Rotten/Lydon – “Ever get the feeling you’ve been cheated?”

  2. Not so sure aMr Woodford can be called a city bod. Perpetual were never a city company and are not even located there. Mr Woodford kept himself to himself and did few interviews until he launched his own companies when he had to get out and about. One thing QE did do was stop the banking crisis in the UK. What stopped the run on Northern Rock happening to RBS etc was printing money some to buy bonds most to buy banks. Without money printing UK would have gone bankrupt.

  3. the elephant in the room 23rd February 2015 at 5:30 pm

    Well that’s how Capitalism works – if that’s the system we subscribe to.

    FYI Phil – Northern Rock were actually taken over by the government and belonged to the tax payer – as does most of RBS and Lloyds group. What is happening in the Eurozone is QE without state ownership.

    We have been sold QE as the only solution – there are others…..

  4. the elephant in the room 23rd February 2015 at 5:34 pm

    And QE has not stopped the banking crisis – we are still in one…..

  5. Elephant in the room

    Yes as I said printing money some to buy bonds (QE) some to buy banks. And UK is not in a financial crisis like 2008 – by no stretch of anyone’s imagination are our banks as badly off as in Ireland, Cyprus, Greece. The Bank of England is doing a reasonably good job. GE has worked for US and for UK and may work for EU and proof is in the ‘eating’ we have weathered the storm. Not sure what Mr Woodford would have done but allowing Northern Rock to go under and then the rest of the financial system to collapse is not my idea of a viable alternative.

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