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| www.bbc.co.uk |
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| Bianco Research: www.arborresearch.com, 27 January 2012 |
What is QE?
Quantitative Easing ("QE") is an expanding of balance sheets via increasing bank reserves. The purpose of QE, as explained by this Bank of England video, is to increase bank reserves through purchases of fixed income securities in order to lower interest rates. This makes fixed income securities relatively unattractive/overvalued and pushes investors out the risk curve. This should increase buying for riskier assets such as stocks, pushing them higher in price. Theoretically these higher prices should lead to a wealth effect and increased economic activity. see
Everybody (else) is doing it
The major economies of the world are exercising monetary policy in order to stimulate economic activity as the first chart shows.
By contrast, the Australian economy is undergoing an unprecedented mining boom at the same time as other sectors of the economy are contracting. We call this our "two-speed" or "patchwork" economy. Some argue it's a manifestation of "dutch disease". The Gillard Government's trade policy is premised on the following:
Non-mining businesses seeking to retain their employees and contractors will need to bid for them against extremely profitable mining-related businesses. And since the mining boom is not confined to Australia, overseas bidders have also entered the market for Australian expertise. Similarly, the prices of materials and equipment used in mining-related activities are being bid higher.
An independent, inflation-targeting Reserve Bank, confronted with these price pressures, would be obliged to consider raising interest rates to prevent inflation from rising above its 2-3 per cent band of tolerance. The blunt instrument of interest rates hurts non-mining businesses and regions of Australia, accentuating the patchwork economy.
A further natural economic consequence of the mining boom is a rising exchange rate, the Australian dollar having surpassed parity with the greenback in November 2010 for the first time since well before the currency was floated in 1983. A high Australian dollar has the desirable consequence of putting downward pressure on prices by lowering the cost in Australia of imported goods and services — taking some pressure off the Reserve Bank to lift interest rates. But a high Australian dollar is also damaging our import-competing and export industries, weakening their ability to compete for productive resources against mining-related industries. While this, too, has an anti-inflationary effect, it is more deeply embedding the patchwork economy.
What to do?
Where does all this money printing leave the Australian investor? Holding your deposits in cash eats away at their value longer term if inflation kicks in. How does the SMSF Trustee determine the best course for achieving the returns required to fund retirement?
You could take the risk of riding the upward trajectory of the risk markets such as stocks. The risk is described well here
Until a worldwide exit strategy can be articulated and understood, risk markets will rise and fall based on the perceptions and realities of central bank balance sheets. As long as this is perceived to be a good thing, like perpetually rising home prices were perceived to be a good thing, risk markets will rise.
When/If these central banks go too far, as was eventually the case with home prices, expanding balance sheets will no longer be looked upon in a positive light. Instead they will be viewed in the same light as CDOs backed by sub-prime mortgages were when home prices were falling. The heads of these central banks will no longer be put on a pedestal but looked upon as eight Alan Greenspans that caused a financial crisis.
The tipping point between balance sheet expansion being bullish for risk assets versus bearish is impossible to know.
A new option for Australian investors
One new option is to consider a high interest cash exchange traded fund such as Beta Shares new offering, the Australian High Interest Cash ETF.
Characteristics of this product include:
- diversification of investment portfolio - the product as part of a cash or term deposit allocation aims to earn a higher rate of interest than the 30-day bank bill swap rate after fees and expenses
- suitability for cash flow for SMSF pension holders - monthly income payments may be made
- the ETF is backed by deposit with an Australian bank trading under new ASX AQUA rules
- investors buy and sell units in the ETF through a broker (and pay brokerage)
- as interest is earned each day on the deposit, the value of the ETF will rise, providing investors with liquidity, coming with the ability to sell at any time without penalty (in contrast to term deposits).
We note:
- the Government Guarantee on bank deposits for Australians is now limited to $250,000 per deposit with one bank/ADI (authorised deposit taking institution). Participation in a cash ETF does not equate to a deposit for the purposes of the government guarantee.
- A Cash ETF provides the possibility for a spread of risk from one institution to many, exposing the investor to multi-party credit risk akin to the former Macquarie Bank Cash Management Trust product. (Note: the current Macquarie CMA attracts single party credit risk).
- the BetaShares Cash ETF currently only offers single bank risk (Westpac) though the PDS describes the possibility of deposits with other major Australian Banks: see here Accordingly, we recommend this is a product to watch, and once they and others offer diversification of credit risk we would recommend our clients to consider these products.
There are similar new products coming onto the market in Australia such as offerings from iShares and Russell Investments. You can read more about these products in The Age/SMH or call us to have a chat about your needs and risk appetite.
Please note this is not financial advice and you should not rely on opinion/s expressed in this blog post.
Please note this is not financial advice and you should not rely on opinion/s expressed in this blog post.
