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https://www.ft.com/content/ec16193f-8728-445e-a456-530f2ca9d791

Michael Mackenzie SEPTEMBER 4 2020 60 Print this page A potent catalyst for equity and credit
markets in recent months has been the combination of ultra-loose monetary policy from central
banks and huge spending by governments. It has inspired a sense of confidence in financial
markets that has turned into euphoria, notably in big US technology stocks. This week, such shares
finally started showing signs that they were hitting their limits. Given the current US policy mix
that penalises investors sitting on the sidelines and holding cash — given they are earning next to
nothing in interest — any cooling of a red-hot market is easily framed as an opportunity. For many,
it is another chance to “buy the dip”. Plenty of asset managers argue that aggressive policy actions
to support asset markets compel them to stick with equities and credit over the medium term.
Such thinking is backed up by historical evidence that equities move higher well ahead of an
extended economic recovery. Money managers’ current annual return expectations of around 5
per cent over the next five years for the S&P 500 stock index may not look that exciting. But that
performance starts to look a lot better in a world of sustained ultra-low yields on fixed income. But
financial history also offers cautionary tales. After an initial boom, “whatever it takes” policy
responses can leave equity markets languishing in their wake. Asset-price bubbles in Japan, South
Korea and Taiwan during the late 1980s, and in Thailand, Malaysia, the Philippines and Indonesia
in the 1990s, are reminders of the long downsides that can follow. Inside ETFs The FT has teamed
up with ETF specialist TrackInsight to bring you independent and reliable data alongside our
essential news and analysis of everything from market trends and new issues, to risk management
and advice on constructing your portfolio. Find out more here Take, also, China’s huge spending in
the wake of the financial crisis, which culminated in an equity bust in 2015. Today, the CSI 300 sits
a tenth below that high water mark, even after Beijing’s renewed efforts at stimulus this year.
Excluding technology, media and telecoms, China’s share market performance has lagged global
peers since 2011, according to BCA Research. Some strategists blame huge spending initiatives
over the past decade that have created a vast misallocation of capital and stalling productivity in
the world’s second-biggest economy, which continue to cast a shadow over equity market
performance. Arthur Budaghyan, chief emerging markets strategist at BCA, argued that, over time,
excessive stimulus and easy money policies led either to asset bubbles or a burst of inflation. Both
outcomes “bode ill for share prices in the long run”, he said. No other economy and equity market
stands out more in this regard than that of the US. The latest official projections show a federal
budget deficit of $3.3tn this year, or 16 per cent of gross domestic product — the largest since
1945. Government debt is forecast to exceed the size of the economy next year, before going on
to hit a debt-to-GDP ratio of 107 per cent in 2023. That is the highest in the nation’s history,
according to the Congressional Budget Office. This debt binge, which extends to many US
companies too, is encouraged by expectations of very loose monetary policy over the longer term.
A rapid expansion of the Federal Reserve’s balance sheet to $7tn — up from $4.15tn in March —
appears only the start, given the renewed focus of central bank officials in boosting inflation and
reducing unemployment, while paying less attention to the potentially nastier consequences of
stimulative policies. So where does this leave investors? Recommended Free LunchMartin Sandbu
How to be a dove Premium In one respect, the possibility of disappointing US equity returns over
the coming five years cannot be dismissed, given how quickly Wall Street has rebounded in recent
months. Plenty of good news is priced in to the S&P 500’s current 12-month trailing price-to-
earnings ratio of 27 times, which implies a substantial pick-up in earnings growth and productivity.
Some are hopeful this can happen. James Paulsen, chief market strategist at the Leuthold Group,
expected the scale of fiscal and monetary support around the world “can break the trend of global
stagnation and deflation”. The importance of such an outcome for Wall Street is underscored by
the high ownership of US equities among both domestic and international investors. This kind of
positioning in dollar assets looks vulnerable, should the current US policy mix continue to weaken
the buck, even testing faith in its reserve currency status. BCA’s Mr Budaghyan conceded that a
period of higher productivity that boosted capital returns and lifted output beyond demand could
keep asset bubbles and inflation at bay. But such an outcome “is easier said than done”, he
cautioned. US policymakers have a formidable challenge ahead to ensure that stimulus policies do
not overstay their welcome. Meanwhile, investors must hope that technological advances will
indeed lift the efficiency of the broader economy as it recovers from the Covid-19 shock. 
michael.mackenzie@ft.com