Laith Khalaf, Hargreaves Lansdown

Hargreaves Lansdown investigates a decade of QE

Hargreaves Lansdown has produced a detailed note marking the tenth birthday of quantitative easing (QE) on 5 March 2019.

Laith Khalaf, senior analyst at Hargreaves Lansdown, comments that when, 10 years ago, interest rates were cut to 0.5 per cent, it followed on from the third of March 2009 when the FTSE 100 hit rock bottom. The index since has doubled in value.

The statistics reveal that GBP1 invested in the UK stock market would now be worth GBP2.53 in real terms, while GBP1 held in a typical instant access account is now worth 87p in real terms.

Over that period, UK house prices have risen 43 per cent, and almost doubled in London. QE has saved the government GBP109 billion in interest payments.

Khalaf says: “We’ll never know what would have happened without QE, but chances are it would have been pretty dreadful. Today the economic picture in the UK is still downbeat, largely thanks to Brexit, but it’s a far cry from the fear which pervaded markets in the depths of the financial crisis.

“At the beginning of 2009, it looked like the whole financial system could topple, and take the global economy with it, and the actions of central banks across the world at least steered us away from that catastrophe. Ultra-loose monetary policy has caused its own problems though, particularly for cash savers and income-seekers.

“Hindsight tells us the beginning of 2009 was actually a tremendous time to invest in the stock market, despite extremely negative sentiment. It goes to show the best times to invest are often when it feels most uncomfortable.”

Looking forward, Hargreaves Lansdown believes that Quantitative Easing will give way to Quantitative Tightening as central banks look to unwind the extraordinary measures they took to support the global economy in the aftermath of the financial crisis. Indeed, the US has already started down this path, the firm says.

The monetary tailwinds that have propelled some asset classes along therefore look set to reverse, and so progress from here will depend more on fundamentals, rather than a rising tide simply lifting all the boats.

Khalaf says: “We shouldn’t expect QE to disappear quickly though. Monetary policy may yet have to loosen again to fend off a slowdown before it tightens sufficiently to eliminate QE. It would not be too surprising to find some QE still swimming around the system in five, or even ten years’ time.

“In the meantime, the principles of investing in the stock market remain the same. It’s a good option for the long term, though there’s no point trying to time the market by second guessing the impact of political or economic decisions. Instead investors should seek to put money to work in the stock market at regular intervals throughout their working lives, while keeping enough cash for their short term needs.”

The data gathered by Hargreaves Lansdown shows that in terms of UK shares, QE helped provide confidence and liquidity to markets, and has been a positive force for markets and investors. Each GBP1 invested in the UK stock market in March 2009 would now be worth GBP3.15 with dividends reinvested, or GBP2.53 once inflation is taken into account.

That’s based on the return of the FTSE All Share, individual investors may have done better or worse depending on where they invested. The average UK equity fund has turned GBP1 into GBP3.08 (IA UK All Companies sector).

The research shows that within the UK, small and midcaps have been the place to be, returning more than the big blue chips in the last decade. These areas of the market tend to be worse hit when there is a sell-off, but rise further when markets are buoyant. GBP1 invested in the FTSE 250 has returned GBP4.25 and into the FTSE Small Cap has returned GBP4.31. The AIM market however has lagged behind the main market indices, returning GBP2.70 on GBP1 invested.

In terms of UK Bonds, bond investors have also done well, unsurprisingly seeing as through QE, the Bank of England has bought GBP445 billion of this asset class. Each GBP1 invested in corporate bonds in March 2009 would now be worth GBP2.16, if invested in UK gilts it would be worth GBP1.61 and if invested in UK index-linked gilts it would be worth GBP2.24.

The strength of the UK bond market has been a continual surprise for a plethora of naysayers in the last decade, Khalaf says, who have quite rightly pointed out the extremely high valuations on these securities, but have nonetheless watched them crunch upwards. They say you shouldn’t fight the Fed, and that looks to apply just as well to the Old Lady of Threadneedle Street. It’s not just the central bank who’s been a consistent buyer of government bonds either, UK pension funds have been piling into the asset class to de-risk their schemes.

Looking internationally, investors who plumped for the US have beaten the pack globally. Hargreaves Lansdown writes that UK investors will have enjoyed even bigger returns from the US market thanks to the depreciation of the pound over this period, which has fallen from USD1.41 to USD1.33 at the time of writing. The US of course had its own, much bigger, QE programme, which is now being unwound, but that doesn’t seem to have knocked the market too far out of its stride.

Goldbugs have enjoyed a lesser return of 43 per cent in dollar terms, the firm writes. That this isn’t perhaps as high as one might expect given the huge global currency devaluations prompted by QE. However the precious metal did peak at over USD1,800 an ounce in 2011 before falling back, it now stands at around the USD1,330 mark. QE benefited gold as a store of value while electronic money printing devalued global currencies, but also as a safe haven in lieu of bonds, when yields fell to such low levels the risk-reward profile was unattractive enough to push many rational investors into other assets.

One of the key impacts of ultra-loose monetary policy has been a collapse in the interest paid on cash savings.  Over this period a typical instant access account has returned just 7.6 per cent, behind the rate of inflation, meaning on average consumers have actually seen the buying power of their deposits go backwards. GBP1 held in one of these cash accounts would now be worth GBP1.08 with interest rolled up, but that falls to just 87p after inflation is taken into account (CPI to be precise).

Notice accounts, including fixed term bonds, have done better over the period. GBP1 in these accounts have on average yielded GBP1.21 today, but again that falls to just 98p once inflation is factored in.

Hargreaves Lansdown writes that the flip side of the decade of poor returns endured by cash savers is that borrowers have had an easy ride. Ultra loose monetary policy has kept mortgage rates low, with the average mortgage interest rate falling from 4.8 per cent at the end of 2008 to 2.5 per cent today.

“That’s of course boosted the housing market. The average UK property has risen in value from GBP149,709 to GBP214,178 since the beginning of 2009. However, that growth hasn’t been evenly distributed across the UK. London has been at the epicentre of price increases, with the average property almost doubling in value in ten years. Meanwhile property prices in Northern Ireland still stand close to the level they did 10 years ago.

The UK economy has grown by 18.5 per cent from its trough in 2009, which works out at an annualised rate of 1.9 per cent as lower borrowing costs have helped the economy recover from the financial crisis.

Unemployment has fallen from 7.9 per cent in 2009 to 4.1 per cent now, though wages have struggled to keep pace with inflation over this period. In real terms, average weekly wages have risen from GBP485 in March 2009 to just GBP494 today, and they still stand below the GBP525 peak reached in February 2008.

Companies with debt on their balance sheet have also benefited from QE, the study shows. The typical borrowing cost for a UK investment grade companies has fallen from 9.2 per cent in March 2009 to 3.1 per cent today.  Those companies with pension deficits have seen their contributions rise as a result of QE however which will have offset the benefits of lower borrowing costs to some extent.

The government has also benefited from lower interest rates on its debt as a result of QE. The benchmark 10 year gilt rate, which reflects the UK government’s cost of borrowing for a 10 year period, has fallen from 4.5 per cent in September 2008 to 1.2 per cent today.

In addition, the government pays just bank base rate on the GBP435 billion of gilts held by the Bank of England, rather than the full interest rate on the bond in question. In total this has helped the government to save GBP109 in debt interest in the last 10 years, and is forecast to save another GBP38 billion by 2024. (Sources: ONS, OBR, HoC Library)

The Hargreaves Lansdown report also looks at best and worst performing shares over the period. They write that the best performing shares aren’t likely to set pulses racing, but that goes to show it’s been slow and steady which has largely won the race. Companies that have done well provide insurance (Legal & General, Prudential), catering services (Compass Group), accountancy software (Sage) and data services (Experian).

“Legal & General is the top performer. As an asset manager its coffers can be expected to swell with the market. But the company has also enjoyed tailwinds from automatic enrolment into workplace pensions, de-risking in defined benefit schemes, and the rise of passive investing, where it’s one of the market leaders.”

At the other end of the table, shareholders in the mining company Lonmin have been virtually wiped out over the period, with labour unrest in South Africa and low platinum prices hitting profits.

Thomas Cook shareholders have likewise had torrid time, seeing the share price plunge in 2011 as political unrest in North Africa posed an existential threat to the travel operator. The last year hasn’t been kind either, as the heatwave which settled over southern Europe in the summer deterred holidaymakers from travelling south for sun. After such big price falls, neither Thomas Cook nor Lonmin are in the FTSE 100 today.

Tesco also finds itself at the bottom of the performance table; a rising market hasn’t been enough to offset the after-effects of its over-expansion, an accounting scandal, and the grocery market share eaten up by Aldi and Lidl.

While the market has had a good decade, doubling in price, valuations in the UK still look fair. The PE on the market is currently 14.6 times earnings, compared to the 7.3 times it stood at the beginning of March 2009, but in line with its long run average (14.3).

Hargreaves Lansdown writes that its preferred measure of market value is the CAPE ratio, which takes a longer, 10 year view of earnings. On this measure the UK currently stands at 16.5 times historical earnings, compared to 11.4 in March 2009 and a long run average of 19.4.

“Together these measures suggest the UK stock market is currently neither very cheap nor extremely expensive, it’s somewhere in between, despite the ground it’s made in the last ten years since QE was introduced,” the firm concludes.

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