We saw this chart recently and could not let it go without comment. It shows how, since inception in December 2008, the Federal Reserve’s Quantitative Easing (QE) program has matched the rise in the S&P 500. With the market just off its all-time high, more than 80% of the index’s rise during this period has taken place when the program has been active. Just as evident, the market has eased during periods when the program has been dormant (the white vertical bars). Global markets have benefited from the Fed’s program, with the countries and blocs carrying out their own QE (the UK, Japan and the Eurozone) enjoying an extra boost.

The Markets' New Buzzword; "Tapering"

With investors and commentators now looking more frequently at the Fed’s exit strategy, the word ‘tapering’ has started to appear. What is it? Tapering is a soothing and passive word that describes how the markets would like to see the inevitable drawdown and halt to QE. A shock free happy ending will not be that easy to orchestrate. This is because there will be two opposing forces at work.

Scenario one; QE actually does what it was supposed to, so the funds released during the program have prepared the economy well enough without the need for further stimulus. This is what investors want...

Scenario two; the halting of QE has a negative impact on asset prices that have been benefiting the most. Equities would bear the brunt of the inevitable downward adjustment. At the moment, this is what we are likely to get…

Weak Global Growth = Low Gold Price

Looking for an upside to the cessation of the QE program, bond markets may start to pick up as real rates in the US start to rise, strengthening the dollar. Unusually, dollar strength this time will not be accompanied by inflationary concerns. Global growth prospects are weak and likely to remain that way so this removes one of the key perceived attractions of gold. Throughout the QE program, investors have got used to both yield and capital appreciation. At current levels, and moving in a tight range, gold is unlikely to find itself any new fans.

Low Returns from Mainstream Assets to Stay

In 2010 the Fed forecast that economic growth in 2011 would be in the range of 2.9% to 4.5%. The achieved number was below that, at only 1.7%. The trouble with scary macroeconomic stories is that they are remote and there is an element of ‘Well, how does that affect me?’ How about this: as recently as in 2000, half of all the states in the US had a fully funded public sector retirement benefits program. By the end of the decade that had fallen to only one, Wisconsin. In the same year, 2010, the collective underfunding on these pension funds was assessed at $1.4 trillion. This is an unimaginably high figure but by coincidence it is close to the total cost of the wars in Iraq and Afghanistan allocated by Congress to date, which is $1.5 trillion according to Cost of War. There is no way that the US pension under-funding gap will be closed, even with equity markets at record levels. Do not forget that a substantial part of the investment portfolios would have been invested in the (weak) bond markets.

Space precludes us in this article from discussing the implications of low investment returns on people’s ability to retire with a degree of security and comfort. It is something we have touched on in the past but we will return to it very shortly. Simply put: lower growth results in lower returns. This is not something that a lot of investors have digested and is not something that the ever-optimistic investment industry wants to advertise. Instead of waiting for ‘reversion to mean’ investment returns, i.e. higher returns that we all got used to in the past, lower returns will be the new mean and by sticking to traditional asset classes, investors will have no chance to break out of the cycle. All forms of alternative assets will be making up a higher proportion of successful investment portfolios in the years to come.