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Wall St ImageKey points

- The Fed’s decision not to taper reflects a desire to see stronger US economic growth and guard against uncertainties around coming US budget discussions.

- The Fed clearly remains very supportive of growth and this will help growth assets like shares, albeit there may still be a speed bump in the month ahead.


In what has perhaps been the biggest positive policy surprise for investors this year, the US Federal Reserve decided not to start tapering its quantitative easing (QE) program and leave asset purchases at $US85bn a month. This followed four months of almost constant taper talk which had led investment markets to factor it in. As a result the decision not to taper combined with very dovish language from the Fed has seen financial markets celebrate. This note looks at the implications.

Ready, set…stop

With the Fed foreshadowing from late May, that it would start to slow its asset purchases “later this year”, financial markets had come to expect that the Fed would start tapering at its September meeting. In the event the Fed did nothing. Several factors explain the Fed’s decision:

  • The Fed always indicated that tapering was conditional on the economy improving in line with its expectations whereas recent data – particularly for employment and some housing indicators – has been mixed.
  • Second, the Fed has become concerned that the rapid tightening of financial conditions, mainly via higher bond yields, would slow growth.
  • Third, the upcoming budget and debt ceiling negotiations (with the risk – albeit small – of a Government shutdown or technical default) and accompanying uncertainty appear to be worrying the Fed.
  • Finally, the Fed may have concluded that any forward guidance it would have provided to help keep bond yields down may have lacked sufficient credibility given the coming leadership transition at the Fed.

Observing the run of somewhat mixed data lately and the back up in bond yields, I and most others concluded that the Fed would address this by announcing a small tapering, ie cutting back asset purchases by $US10bn a month, and issue dovish guidance stressing that rate hikes are a long way away in order to keep bond yields down. However, it turns out that the Fed is more concerned about the risks to the growth outlook from higher bond yields at this point than we allowed for particularly given the US budget issues.

The Fed’s announcement is ultra-dovish with tapering delayed till “possibly” later this year and the Fed further softening its guidance. For example, the mid 2014 target for ending QE is gone and the 6.5% unemployment threshold for raising interest rates has been softened with Bernanke saying rates may not be increased till unemployment is “substantially” below 6.5%. The median of Fed committee members is for the first rate hike to not occur until 2015, and for the Fed Funds rates to hit only 1% at the end of 2015 and 2% at the end of 2016.

The key message from the Fed is very supportive of growth. They won’t risk a premature tightening in financial conditions via a big bond sell off and tapering won’t commence until there is more confidence that its expectations for 3% growth in 2014 and 3.25% growth in 2015 are on track.

Given that we also see US growth picking up tapering has only been delayed, but there is considerable uncertainty as to when it will commence. The Fed’s October 29-30 meeting looks unlikely as there is no press conference afterwards and US budget concerns may not have been resolved by then. The December 17-18 meeting is possible as it is followed by a press confidence but is in the midst of holiday shopping. So it could well be that it doesn’t occur till early next year.

Perhaps the main risk for the Fed is that by not tapering (when it had seemingly convinced financial markets that it would) it has created a lack of clarity around its intentions which will keep investors guessing as to when it will commence. This will likely add to volatility around data releases and speeches by Fed officials.

The US economy and inflation

In a broad sense though, the Fed is right to maintain a dovish stance:

  • Growth is on the mend thanks to improving home construction, business investment and consumer spending but it’s still far from booming and is relatively fragile as the private sector continues to cut debt ratios. This is also evident in the mixed tone of recent economic indicators with strong ISM business conditions readings but sub-par jobs growth and some softening in housing indicators on the back of a rise in mortgage rates to a still low level of around 4.6%.
  • Spare capacity is immense as evident by 7.3% official unemployment, double digit labour market underutilisation and a very wide output gap (ie the difference between actual and potential growth).

Source: Bloomberg, AMP Capital

  • A fall in labour force participation has exaggerated the fall in the unemployment rate. At some point participation will start to bounce back slowing the fall in unemployment.
  • Inflation is low at just 1.5%. There is absolutely no sign of the hyperinflation that the Austrian economists and gold bugs rave on about.

So while some will express annoyance that the Fed has confused them, at the end of the day the economic environment gives the Fed plenty of reason to be flexible.

Implications for investors

The Fed’s decision to delay tapering for now and its growth supportive stance is unambiguously positive for financial assets in the short term and this has been reflected in sharp falls in bond yields, gains in shares and commodity prices and a rise in currencies like the $A.

The sharp back up in bond yields since May when the Fed first mentioned tapering had left bonds very oversold and due for a rally. This could go further as market expectations for the first Fed rate hike push back out to 2015. However, the Fed has only delayed the start of tapering and as the US/global growth outlook continues to improve the upswing in bond yields is likely to resume, albeit gradually. This and the fact that bond yields are very low, eg 10 year bonds are just 2.7% in the US and just 3.9% in Australia, suggests that the current rally will be short lived and that the medium term outlook for returns from sovereign bonds remains poor.

For shares, the Fed’s commitment to boosting growth is very supportive. QE is set to continue providing a boost to shares going into next year even though sometime in the next six months it’s likely to start to be wound down. But it’s now very clear that the Fed will only do this when it is confident that economic growth is on track for 3% or more and this will be positive for profits. This is very different to the arbitrary and abrupt ending of QE1 in March 2010 and QE2 in June 2011, that were associated with 15-20% share market slumps at the time. See the next chart.

Source: Bloomberg, AMP Capital

With shares no longer dirt cheap, it’s clear that the easy gains for share markets are behind us. But by the same token shares are not expensive either and an “easy” Fed adds to confidence that profit growth will pick up next year driving the next leg up in share markets.

Source: Bloomberg, AMP Capital

Shares are also likely to benefit from long term cash flows as the mountain of money that has gone into bond funds since the GFC is reversed gradually over time with some of it going into shares. See the next chart.

Source: ICI, AMP Capital

However, while the broad cyclical outlook for shares remains favourable, there will be some speed bumps along the way. The coming government funding and debt ceiling negotiations in the US could create uncertainty ahead of the usual last minute deal. And investors will now be kept guessing about when the first taper will come which means any strong economic data or hawkish comments from Fed officials could cause volatility. The May-June share market correction was all about pricing in the first taper and that process might have to commence all over again at some point.

For high yield bearing assets generally, eg bank shares, the Fed’s inaction and the rally in bonds will provide support. However, underperforming cyclical stocks, such as resources, may ultimately be more attractive as they offer better value and will benefit as the global and Australian economies pick up.

For emerging world shares, the Fed’s inaction takes away some of the short term stress, but it’s likely to return as US tapering eventually comes back into focus with current account deficit countries like India, Indonesia and Brazil remaining vulnerable.

Finally, the Fed’s decision not to taper does make life a bit harder for the Reserve Bank of Australia in the short term in trying to keep the $A down. It has added to the short covering bounce that has seen the $A rise from $US0.89 this month and so adds to the case for another interest rate cut. However, the rebound in the $A is likely to prove temporary as the Fed is expected to return to tapering some time in the next six months.

Dr Shane Oliver
Head of Investment Strategy and Chief Economist
AMP Capital


DISCLAIMER: The above information is commentary only (i.e. our general thoughts).  It is not intended to be, nor should it be construed as, investment advice.  To the extent permitted by law, no liability is accepted for any loss or damage as a result of any reliance on this information.  Before making any investment decision you need to consider (with your financial adviser) your particular investment needs, objectives and circumstances.

Wednesday, 18 September 2013 16:08

Platinum Asset Management - Investment Approach

We have long been supporters of Platinum Asset Management's ability to manage International investments.

Here is a brief 3 minute video that outlines more about their process and thinking takes place in their management of money.


DISCLAIMER: The above information is commentary only (i.e. our general thoughts).  It is not intended to be, nor should it be construed as, investment advice.  To the extent permitted by law, no liability is accepted for any loss or damage as a result of any reliance on this information.  Before making any investment decision you need to consider (with your financial adviser) your particular investment needs, objectives and circumstances.

Wednesday, 11 September 2013 09:37

Banned iPhone 5 commercial

With the release of the latest iPhone 5 - we thought it appropriate to wheel out a satirical banned commercial for iPhone 5.

Wednesday, 11 September 2013 09:31

Telstra trials NBN beating internet

logo-blueTelstra Corp Ltd has reportedly begun trials of new mobile technology that is being billed as capable of providing download speeds as much as nine times faster than the coalition's national broadband network (NBN) plan would deliver, according to The Australian Financial Review.

Labor's NBN plan offered customers up to 100 megabits per second, while the coalition is pushing a plan that would guarantee speeds of 50 mbps by 2019.

Telstra plans involve using a technology called “carrier aggregation” aimed at delivering peak mobile download speeds of up to 450 mbps, according to a Telstra strategy briefing cited by the AFR.

Telstra's current 4G wireless network delivers download speeds of up to 40 mbps.

During the federal election campaign, the coalition argued that the prospect of super-fast mobile technology did not threaten to undermine the NBN, but rather bolstered their plan for a cheaper network because the rise of mobile technology reduced the need for a large-scale network.

The rise of mobile computing has truly been astonishing in the last 5 years since the introduction by Apple of the first iPhone in 2007.

Like the rail road industry in the US in the 1800's, that resulted in the rise of many complimentary industries, so too we see the rise of industries that are connected to the massive increase in mobile computing and e-commerce.  Facebook, Twitter, eBay are now household names that did not exist all that long ago.

While acknowledging that the late 1990's saw a share market tech boom that ended badly, we are now seeing a boom of e-commerce that is of a different quality.

Investors can choose to ignore this and focus on traditional companies, however e-commerce is likely to impact all forms of business and it's impact must be considered when making investment decisions.

By means of an example, the below chart shows the growth in smart phones in China since 2009.  Chinese e-commerce has grown over 70%pa since 2009.

Chinese Smartphone shipments

This growth theme is difficult to play from Australia given our small population by world standards.

We can report however that both Platinum Asset Management and Magellan Financial Group are both well and truly on top of developments in e-Commerce generally and more specifically in China.

This material has been provided for general information purposes and must not be construed as investment advice. This material has been prepared without taking into account the investment objectives, financial situation or particular needs of any particular person. Investors should consider obtaining professional investment advice tailored to their specific circumstances prior to making any investment decisions and should read the relevant Product Disclosure Statement.


Friday, 04 October 2013 16:47

China - is it the next US sub-prime?

Mark Draper (GEM Capital) talks with Andrew Clifford (Chief Investment Officer - Platinum Asset Management) about the stress that the Chinese credit system is under.

Andrew provides his view on whether China is the next US sub-prime crisis waiting to happen and outlines the sectors he would avoid given what is going on in China at the present time.

Andrew manages the Platinum Asia Fund and is in an excellent position to comment on the current situation in China.

Mark Draper (GEM Capital) talks with Andrew Clifford (Chief Investment Officer - Platinum Asset Management) about the threat to Australian Banks from the new entrants to the payments system such as Paypal.

Andrew acknowledges the risks are real and outlines the signs that investors should be looking for.

Sunday, 25 August 2013 07:52

The election is now in it's 5th year

Comedians Clarke and Dawe talk about the election that feels like it is in it's 5th year.

Franklin Templeton investors have produced a series of videos on Behavioural patterns of investors.


Here is one of the series on "Following the herd"

Image 1With the election campaign trail hotting up, do you find yourself wanting to throw a sandwich or a shoe at either (or both) of our political leaders.

Well, now you can.

The free to download iPad / iPhone application called "Abbott vs Rudd" can be found in the App Store by searching for 'election'.

The game allows the user to either throw a sandwich or a shoe at either candidate, scoring  higher points for a head shot.  Gamers also have the pleasure of being able to stop the candidate talking with an accurate shoe shot as real voice audio is contained in the game.

Bonus points are awarded for repeat accuracy.  Julia Gillard even makes random entries onto the screen shouting out "mysogynist", and additional points are given for smearing a sandwich on our first female Prime Minister.


(Screen shot of application)

While clearly not a game for the whole family, this little application may just help you vent your electoral frustrations between now and the 7th Sept, without requiring any bail money.