Editorial & Advertiser Disclosure Global Banking And Finance Review is an independent publisher which offers News, information, Analysis, Opinion, Press Releases, Reviews, Research reports covering various economies, industries, products, services and companies. The content available on globalbankingandfinance.com is sourced by a mixture of different methods which is not limited to content produced and supplied by various staff writers, journalists, freelancers, individuals, organizations, companies, PR agencies Sponsored Posts etc. The information available on this website is purely for educational and informational purposes only. We cannot guarantee the accuracy or applicability of any of the information provided at globalbankingandfinance.com with respect to your individual or personal circumstances. Please seek professional advice from a qualified professional before making any financial decisions. Globalbankingandfinance.com also links to various third party websites and we cannot guarantee the accuracy or applicability of the information provided by third party websites. Links from various articles on our site to third party websites are a mixture of non-sponsored links and sponsored links. Only a very small fraction of the links which point to external websites are affiliate links. Some of the links which you may click on our website may link to various products and services from our partners who may compensate us if you buy a service or product or fill a form or install an app. This will not incur additional cost to you. A very few articles on our website are sponsored posts or paid advertorials. These are marked as sponsored posts at the bottom of each post. For avoidance of any doubts and to make it easier for you to differentiate sponsored or non-sponsored articles or links, you may consider all articles on our site or all links to external websites as sponsored . Please note that some of the services or products which we talk about carry a high level of risk and may not be suitable for everyone. These may be complex services or products and we request the readers to consider this purely from an educational standpoint. The information provided on this website is general in nature. Global Banking & Finance Review expressly disclaims any liability without any limitation which may arise directly or indirectly from the use of such information.

TAPER TANTRUM WAITING TO HAPPEN?

Since the Fed started its massive bond-buying programme (QE3) in September 2012, the S&P 500 has enjoyed a spectacular bull market that has, by some metrics, detached from any semblance of fundamental value. At the same time, money has flocked to emerging markets in search of return. With the end of QE3 looming in October 2014 and interest rate rises in 2015, analysts and investors can be forgiven for thinking this is a bubble waiting to burst.

These fears are not entirely unjustified. In the second quarter of 2013, emerging markets experienced what is now referred to as the “taper tantrum”; a period of rapid devaluation following the Fed’s announcement of a gradual end to QE3. So will the next 15 months end the easy ride for equities and emerging markets, or will they prove to be more resilient to rate hikes than previously thought?

The Fed’s balance sheet

This question can be answered by looking at the US Federal Reserve’s balance sheet – as noted by my friend Joshua Wilks, an institutional portfolio manager – which shows a clear correlation between its pace of expansion and the S&P 500’s growth since 2012. The S&P 500 Index was up almost 20% year-on-year to March, during a time when average reported earnings per share for the companies grew just 2.68% in the same period – that’s without even considering inflation.

An orthodox explanation of this is fairly simple; the Fed’s loose monetary policy and massive asset purchasing programme has lowered asset yields globally. As a result, investors have been crowded out of safe assets such as government fixed income and into equities and emerging markets. Because markets like Brazil, China, India, Turkey, and South Africa are viewed as risky in relation to those in developed countries, both equities and fixed incomes in these markets are far more sensitive to global investor sentiment for risk.

Global resilience

As this thinking goes, now that the Fed is winding down QE3 and is eyeing a rate hike in mid-2015, the easy ride for both the S&P 500 and emerging markets may be coming to an abrupt end. However, the SPX has shown a far tighter correlation to the size of the Fed’s balance sheet than to yields on US treasuries.

TAPER TANTRUM WAITING TO HAPPEN? 1The implications of this going forward are that even though the Fed may raise interest rates in mid-2015, the S&P 500 may not react with immediate collapse because it is sensitive to the Fed’s actual balance sheet, not to prevailing interest rates. Crucially, the Fed is likely to refrain from unwinding its balance sheet until after its first rate hike, meaning, in short, that judgement day may not come until the Fed begins to actually wind down its balance sheet. Therefore, markets that have benefitted from the Fed’s bloated book could continue to perform well until well after the first Fed hike. There is also the European Central Bank, which has announced its own asset-purchasing programme that should increase its balance sheet by approximately one trillion euros, equating to a quarter of the Fed’s present balance sheet.

Risk factors such as geopolitical conflict and falling demand for commodities from China’s slowing manufacturing and construction sectors remain. However, the continued glut of liquidity from the Fed and ECB will mean that a level of support will remain beyond the initial rate hikes in 2015. Emerging markets may decouple from each other in 2014 as strong performers with growing economies and resurgent returns continue to prove more attractive than stagnating economies with high government deficits. Investors who can tell the difference will therefore be able to continue finding exceptional returns, with any luck avoiding another taper tantrum along the way.

Ranko Berich, Head of Market Analysis at Monex Europe