Posted on: 15 April 2015
The amount of liquidity in the
global financial system continues to grow, thanks to massive
quantitative easing (QE) programmes in both the Eurozone and
Extraordinary monetary policy
measures have been in force in a number of countries across the
world since 2008, after global central banks were forced into
co-ordinated action to limit the possibility of the financial
system falling to pieces. At varying times since then, five major
central banks have printed money via QE programmes - ostensibly to
boost demand via cheap money within their respective economies.
The US may have curtailed its QE
programme, but with neither the Japanese nor Eurozone economies yet
out of the woods, it would be surprising if QE did not continue in
some form or another around the world in the near term.
So, what impact has QE had so far?
Almost without fail, currencies
have been impacted by QE, with significant US dollar, euro, yen,
krona and sterling weakness during periods of easing. We have
argued before that currency weakness was likely an intended result
of QE (despite protestations to the contrary), and the Eurozone's
recent foray into QE appears no different.
It has also contributed to lower
levels of volatility across asset classes, as well as significant
inflows into equity markets - as bond yields have trended lower,
investors seeking higher rates have been forced into more volatile
assets, including equities. This, in turn, can contribute to equity
prices becoming detached from their fundamental valuations, as
these investors may value the equity market based on its income
yield rather than its earnings.
What do we mean by this? In the
long term, the price change of equity markets should reflect the
change in the earnings of the underlying companies. However, in the
short term, equity prices can deviate some distance from the
underlying earnings, due to many factors - including QE.
Should we be concerned? QE has
helped equity markets perform well since the financial crisis, even
in the face of poor economic and earnings data. As outlined above,
QE is likely to continue until economic growth in the Eurozone and
Japan becomes more self-sustaining, suggesting that there should be
some support for equity markets for now. Valuations have also been
supported by low and steady inflation, which is also likely to
remain the case for a while longer. If earnings grow more quickly,
then equity valuations may improve and better reflect
The European Central Bank - led by
Mario Draghi - has successfully brought about a 28% fall in the
value of the euro versus the US dollar over the past 12-months.
This should help make the Eurozone more competitive in global
trade, but may also be a headwind to US growth. It is unclear
whether Europe can take up the slack if the US begins to slow more
sharply, but both regions remain very important for the UK market:
approximately 27% of UK large cap earnings come from the rest of
Europe, versus 24% from the US.
While macroeconomic factors appear
to be broadly supportive of equities, the divergence among central
banks with respect to monetary policy and the resulting impact on
both currencies and equities is likely to cause volatility
throughout 2015. Q1 saw the biggest intraday moves in the USD/EUR
since the single currency was first introduced, and as we approach
the Fed's expected interest rate rise, more volatility is likely.
This causes us to remain cautious, and maintain a well-diversified
position across asset classes and geographies.
 JP Morgan, Guide to the Markets Q1 2015.
All data has been compiled by
Duncan Lawrie from sources believed to be reliable.
Full details of sources are available on
The comments and figures in
this document are generally applicable but you should always take
specific advice to suit your individual
circumstances before taking any action. Errors and omissions
The value of investments and
income generated may fall as well as rise, and investors may not
get back the amount invested. Past
performance is not a reliable indicator of future