Ben Chu: Will the reversal of easing lay waste to shares? We simply don’t know


“Après moi, le deluge,” warned Louis XV. But what about après quantitative easing? What will happen to stock markets when all that easy money created by central banks is sucked back in?  It’s the red-hot question for investors now as the Federal Reserve begins to taper its asset purchases and the Bank of England starts to acknowledge the possibility of rates rising.

The head of the highly regarded Baupost Group hedge fund, Seth Klarman, has created a splash with his prediction of an almighty collapse. “When the markets reverse, everything investors thought they knew will be turn upside-down and inside-out … Few, if any, will escape unscathed,” Mr Klarman wrote in a private letter to clients. He’s firmly in the deluge camp.

That bearish perspective would appear to have some support from the Bank of England’s own research, released in 2011, which suggested that quantitative easing was delivering a major fillip to equity and bond markets. It estimated that the impact of £200bn of asset purchases (at that stage) had delivered a 16 per cent boost to share prices. Extrapolating from that, the full £375bn of purchases has lifted prices by as much as 30 per cent (assuming that QE did not lose its effectiveness over time).

Won’t the withdrawal of QE have the same effect in the opposite direction?

David Miles, a member of the Bank’s Monetary Policy Committee, regards that as a naïve conclusion. He did some modelling in a recent paper which suggests that reversing QE will not, in fact, lay waste to equity markets and bond markets. Mr Miles suggests that because QE will only be withdrawn (one hopes) at a time when financial markets are functioning normally the impact on asset markets will be benign.

So who’s right: the modeller or the trader? There’s no way of knowing for sure. QE on the scale undertaken over the past five years is an unprecedented experiment. That means there is no empirical data or historical studies to guide us.

Mr Miles might be right that the markets will be able to absorb the withdrawal of that liquidity. But it’s possible that the psychological impact on traders will result in a self-feeding downward spiral. The turmoil that broke out in some emerging markets last year when traders were unsure whether the Fed was about to begin to taper off asset purchases is not an encouraging sign. And don’t forget that the taper tantrum was a reaction to the mere slowing down of QE, not its reversal.

Uncertainty reigns. And that’s uncertainty in the sense identified by John Maynard Keynes and Frank Knight: it’s not that we cannot accurately calculate the probabilities involved, it’s simply that we have no scientific basis for doing so.

The advice for investors? Position your portfolio for radical uncertainty in the years ahead.

Wrong man at the Co-op?

We know what Paul Flowers, the former chair of the Co-operative Bank, is alleged to have been smoking. But what about the board of the Co-operative Group?

The mutual is planning to offer a £1.5m “guaranteed bonus” to its new chief executive, Euan Sutherland. That will take his total remuneration to a lofty £3.66m. Mr Sutherland’s predecessor, Peter Marks, struggled along on £1.3m.

Nor does the largesse stop there. The total annual wage bill for senior executives is set to double to £12m. And this in a year in which the Co-op is expected to reveal losses of £2bn and unveil plans for up to 5,000 redundancies.

Co-op is not the only mutual where pay seems increasingly divorced from performance. The total remuneration of Graham Beale, chief executive of Nationwide, for 2012-2013 was £2.26m. This included £400,000 of “annual performance pay” in a year in which profits flatlined and the commercial arm of the Nationwide reported a £452m loss.

The Co-op brought in some “salary consultants” who came up with the remuneration package for Mr Sutherland. That figures. Has there ever been a recorded instance of these kind of consultants recommending lower executive pay?

Ursula Lidbetter, the Co-op’s chairman, argues that the pay hikes reflect “the greater commercial, management and turnaround experience” of Mr Sutherland’s team. But since when did big pay guarantee sensible and competent banking? Has she never heard of Fred the Shred?

Mr Sutherland yesterday took to Facebook to express his annoyance that his pay has been leaked. Such a petulant and ill-judged reaction raises the question of whether he is the right person for the job of rescuing the Co-op. If he insists on this ridiculous remuneration package we will know that the answer is no.

The spectre at the grilling

 Today’s Treasury Select Committee session promises a serious grilling. The committee will take evidence from the Bank of England Governor, Mark Carney, and the Bank’s director of markets, Paul Fisher, on its handling of the foreign exchange rigging scandal. The committee chairman, Andrew Tyrie, released a statement last week which revealed his irritation at the tardiness of the Bank’s governing “court” in taking charge of the internal investigation into what the Bank knew of allegations of rigging. Mr Tyrie lost a protracted battle with the former Governor, Lord King, over the supervisory powers of the court. He will let off steam today. But how Mr Tyrie must wish it was his old adversary Lord King, not the newcomer Mr Carney, in his sights across the table.

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