Cheering the end of QE

The economy is getting better — so why are investors panicking?

a woman

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Imagine this exchange at your local hospital’s intensive care department:

Doctor: “We have great news. The patient is showing signs of a recovery, and we think we should be able to reduce the antibiotics pretty soon.”

Patient’s family: “That’s terrible. We want him to have the antibiotics forever.”

Doctor: “But he doesn’t need them. In fact, some of these drugs, if delivered in very high doses for too long, will have a terrible effect.”

Family: “We can worry about that later. Even if he is recovering, we want the drugs to continue. The risks be damned!”

Doctor: “But he doesn’t need them… he’s on the road to recovery under his own steam. Besides, the drugs were required before, but soon they’ll just be telling his body not to try on its own – that the drugs will always be there. It’ll weaken his system.”

Sound like a crazy scenario? It is. Unless, of course, it’s an analogy for the US financial system.

The economic patient is recovering

US Federal Reserve chief Ben Bernanke told a news conference earlier this week that a gradual reduction of the Fed’s bond buying program could begin this year – or in the parlance, there could be a gradual tapering of QE.

(Clichés and buzzwords are a specialty of financial analysts and commentators – recently we’ve had ‘tapering’ and the ‘great rotation’ and it wasn’t long ago that you couldn’t read the business headlines without seeing ‘green shoots’ everywhere!)

Just like the doctor in our fictional hospital, Bernanke and the Federal Reserve board are seeing a time, perhaps reasonably soon, when these largely unprecedented emergency measures are no longer needed. A time when the US economy (and still, by extension, the global economy) can stand on its own two feet.

And that’s unquestionably great news for the global economy, and for investors. Not that you’d know it by looking at the reaction on the US and Australian share markets. Investors have responded like the fictional family, above – with fear and despair.

Higher rates mean quality is king

There is some validity to the concerns of investors – after all, when interest rates go up, shares become a little less attractive in comparison to returns that can be achieved investing in government bonds. In addition, companies, projects and investing strategies that were reliant on historically low interest rates will come under pressure.

But remember, we’re not talking about interest rates that are significantly above average. Indeed, we’re not talking about interest rates increasing at all just yet. That’s still likely to happen, but maybe not until 2014 or even 2015. By which time, quality businesses will have grown profits, enhanced their competitive advantages and paid more dividends to shareholders. Even when those rates do increase, it’ll be slowly, and from almost-zero to something still below long-term averages for quite a while to come.

So let’s take a step back and think about what Bernanke’s words – and eventual actions – mean. They mean that the economy is getting back in shape. That the worst of the crisis is behind us and that the economy is returning closer to business as usual. Business as usual means consumer spending starting to return to normal, unemployment falling and companies beginning to invest again – all of the things that count towards and will spur further economic growth.

Foolish takeaway

Here in Australia, we’re responding to US news as if the changes were happening on our soil. Or, more accurately, we’re worried that the same thing might happen here, and that the changes to investment appetites on Wall Street will be reflected in Australia.

So what should Australian investors do? Rather than Bernanke’s actions being something that causes markets to lose value, they’re exactly the signs long-term investors should be cheering. And if other investors are selling in a panic, those long-term investors get the opportunity to pick up some bargains.

Exactly what they should have been doing all along. Ignoring the noise and the short term gyrations. Buying shares in great businesses that are selling at good prices.

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