By ROBERT HARLEY 01/12/2010
As anticipated, the US Federal Reserve (Fed) duly confirmed its intention to embark on another round of Quantitative Easing (QE), earmarking an additional $600 billion to purchase US Treasury over the next 6 months - on top of a further $200 billion of QE the Fed committed to in August. The aim is to stimulate economic activity by driving down treasury yields and in turn encourage a rally in other risk assets boosting consumer confidence via a wealth effect. Whilst acknowledging the potential inflationary impact of the measures, we remain sceptical that these proposals will have the desired outcome. In this event it was a case of buy the rumour sell the fact, and corporate bond prices subsequently fell back on the announcement, encouraged by slightly more positive US economic data.
Otherwise the headlines for the month of November were dominated by the Sovereign crisis that has been brewing in Ireland and threat of contagion across Europe. Angela Merkel’s statement at the start of the month that bank bondholders may have to shoulder the some of the burden in the event of future European bail outs initially raised investors concerns. Events have since moved rapidly, culminating in the Irish bail out. Whilst these steps may provide a short term resolution, concerns over the solvency of Irish banking system and for that matter the Irish state are likely to persist – we are not convinced that Ireland will be able to generate sufficient economic momentum to grow out of this problem. Markets have started to shift their focus to Portugal.
Data released following the end of the US 3rd quarter earnings season show that annualised 3rd quarter earnings reached their highest level since records began, supporting the view that the corporate world has bounced back aggressively from the downturn in 2008. We believe some caution is warranted given the uncertainties that persist following the financial crisis. Evidence of a sustainable improvement in the employment picture is likely to be a condition to take share prices to the next level. In the meantime, against a backdrop where interest rates are likely to remain lower for longer, shares seem reasonably well underpinned given their combination of attractive income yields and valuations which are not excessive.