Every year around this time, the world’s most powerful market movers gather in a US holiday resort and make their plans for the global economy.
I’m not talking about some conspiracy-theory-laden offshoot of the Bilderberg Group here. I’m talking about the annual central bankers’ shindig in Jackson Hole, Wyoming.
This Friday, Federal Reserve chief Ben Bernanke will be delivering his big speech.
Plenty of investors are holding their breath, hoping he’ll make some hint at injecting a load of new money into the US economy.
But I think they’re in for a big disappointment…
The Fed Needs to Keep its QE At the Ready
The Federal Open Market Committee (FOMC) last met to discuss the state of the US economy at the start of this month. The minutes from that meeting came out last week, and got everyone very excited. That’s because the FOMC suggested that it might be ready to do more “fairly soon” unless the US economy improved.
By ‘more’, everyone assumes they mean more money printing. So they’re hoping that this Friday, Fed chief Ben Bernanke might give a hint about just how much more printing they plan to do.
But there are many reasons why anyone betting on a third batch of quantitative easing (QE3) from the Fed this year might be disappointed.
There’s Europe, for starters. Plenty of tripwires lie ahead of the eurozone in the next month or so. There’s the German constitutional court’s decision on whether or not the eurozone’s big bail-out mechanism is legal or not. And there’s the usual to-ing and fro-ing over Greece’s financial situation.
Any nasty surprises on these fronts could send the markets into a spasm of panic. So it strikes me that the Fed will probably want to keep its powder dry, in case of emergencies.
Also, the Fed will want to keep the pressure up on Europe. If the European Central Bank (ECB) follows through on its promise to do “whatever it takes” to save the euro, more QE in the US may be unnecessary.
But if the US prints more money, it takes some of the pressure off the Europeans to get their act together.
The US Stock Market Doesn’t Justify QE3
However, the main reason I don’t think we’ll see a full-blown QE3 is because the US stock market is in remarkably good health. Previous bouts of QE have been announced at points where investors have been screaming for the Fed to “just do something!” That’s not the case now. The S&P 500 recently hit a four-year high.
It also doesn’t help that food prices and oil price inflation are back on the radar. QE is meant to be an emergency measure, to prevent the economy from sliding into deflation. With neither deflation nor a stock market collapse panicking investors, it’ll be hard to justify any extreme action.
In other words, the stage is being set for a big disappointment. When Bernanke speaks at Jackson Hole at the end of this week, people will read what they want into his speech. But if the next Fed meeting in September delivers little more than a commitment to “keep interest rates low”, then US markets could take a tumble.
The good news is, if you are a genuine long-term investor, you don’t have to fret too much about what’s going to happen with QE.
We’ve said it before a number of times, but it bears repeating. When it comes to the long-term – which is what we all claim to be investing for – the key to success is to buy stocks when they represent good value.
History shows that if you buy a market when it’s at a historically cheap level, you’ll make a decent return if you hold for the long term (five years or more). If you buy a market when it’s already expensive, then yes, it might get more expensive. But you don’t have much room for error. And you have to make sure that you get out before everyone else realises that it’s expensive, or you’ll lose money when the bubble bursts.
The point is that stocks tend to get cheap when the outlook is gloomy. There’s an argument to be made that the US has better prospects than many developed economies. The US housing market has suffered a proper crash. Its banks are closer to having healthy balance sheets than most other developed nations. And it has the wild card of shale oil and gas up its sleeve.
But it’s in the price. The S&P 500 trades on a CAPE (cyclically-adjusted p/e ratio – which smooths out earnings over ten years) of around 22. That compares to the long-run average of around 16. So if a strong recovery doesn’t materialise, there’s a lot of room for disappointment.
Both European and Japanese markets, on the other hand, are cheap by historical standards, based on the CAPE. So they are pricing in a lot of misery. If things get even a little less worse, then their markets will benefit.
John Stepek
Contributing Editor, Money Morning
Publisher’s Note: This article originally appeared in MoneyWeek (UK)
From the Archives…
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