03.01.2013
By Terry Flanagan

Quantitative Easing Will Push FTSE to Record High in 2013, U.K. Economist Predicts

Equity markets are hopeful that they will continue to receive their fix of quantitative easing going forward as stock markets remain pumped up on this artificial stimulus.

As the world enters the third stage of quantitative easing and with the U.S. and the U.K., among others, seemingly hell-bent on continuing to administer this monetary dose, some economists are optimistic that major benchmark indexes, such as the FTSE 100, will touch new highs in 2013.

“We are likely to see the U.K. finally getting back above its all-time high before the end of this year, primarily because the quantitative money from central banks is going all-out for economic growth,” said John Clarke, an economist and chief investment officer of GHC Capital Markets, a U.K. investment manager.

The FTSE’s record stands at 6,950 from way back in 1999. It is currently hovering around the 6,300 mark.

Clarke is also confident that this apparent ‘great rotation’ back into equities will continue.

“We have analyzed the way the economy operates and quantitative easing is such an obvious way of getting the economy going that equities are the place to be in,” said Clarke.

“Equities, despite their recent run, still have standard valuation measures that are quite low. For instance, the dividend yield ratio on the U.K. equity market is still well below one, which implies investors don’t think that dividends will grow in the long term which is clearly wrong.”

It is the U.S. and U.K. markets that are expected to see the largest uptick from quantitative easing, with the eurozone “not destined to grow significantly”, according to Clarke.

“Financial markets tend to be forward looking so they are anticipating the growth that central banks are prepared to underwrite at the moment,” he said. “The eurozone is the exception to that. Everyone seems to think that quantitative easing is generic. It isn’t.

“It takes various forms. Don’t forget that Japan has been doing quantitative easing since 2001 and has been getting it horribly wrong until recently. What Japan was initially doing was buying assets held by the banks rather than the non-bank private sector. All the banks were doing were sitting on the reserves that were being created.

“But by targeting the non-bank private sector, which is what the Bank of England has been doing and also largely the Federal Reserve, essentially government gilts are being purchased by the central bank from the non-banks.

“This means that the non-bank private sector has got more cash to do something with, and because cash levels are higher than they want them to be they are using those excess cash balances to acquire other assets. That is why equities are going up. As long as that process continues, that’s how quantitative easing works; it is not about getting the banks to lend or anything like that.

“And this is why parts of the eurozone are not destined to grow significantly as the European Central Bank is deliberately not trying to increase the quantitative money. It is under pressure from Germany’s Bundesbank, it has to be said, but by focusing their asset purchasing through Outright Monetary Transactions they are just focusing on short-dated securities which are typically held by the banks and not by the non-banks.”

However, not all market participants, such as pension funds, are happy with quantitative easing, which has driven up government bond prices and reduced yields, and has left many pension funds in something of a quandary.

Pension funds, generally, have been steadily increasing their bond exposures and reducing equity holdings since the mid-1990s and have recently sought greater solace in the ‘safe-haven’ government bond market following the financial crisis, as well as snapping up government bonds to meet new regulatory requirements to hold less risky assets.

But now that these huge rounds of quantitative easing have increased their liabilities, it is forcing pension funds to reconsider a return to higher-risk asset classes such as equities to cut their deficits.

“It is no surprise that some observers argue that a shift into risk assets may help pension schemes,” said Andrew Milligan, head of global strategy at Standard Life Investments, an asset manager, in a recent investor note.

“[But] it may be the wrong medicine at a time when many defined benefit pension funds are cash flow negative and are looking to navigate a complicated end-game, rather than boost risk in their funds.

“It seems unlikely that a dramatic U-turn in equity allocations by pension funds lies ahead. Even for those who see a recovery in global growth as a signal for greater optimism about the outlook for share prices, the policy and regulatory environment is likely to sustain the current risk aversion.”

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