Neil Woodford: Why I’m nervous when QE is lifting all ships

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Invesco Perpetual’s Neil Woodford has reiterated his short-term caution on the markets, noting that loose monetary policy is keeping assets afloat while economic growth remains elusive.

In an update to investors, the manager of the £13.7bn Invesco Perpetual High Income and £10.3bn Invesco Perpetual Income funds said he is “a bit more cautious” – a phrase he has used for the past several months – in his near-term outlook.

“The rising tide of QE has lifted all ships, whether it is in bond markets or equity markets, and given that the fundamental economic backdrop isn’t really improving – and arguably is deteriorating – that makes me slightly more concerned,” the manager says.

“We’ve seen essentially a revaluation of bonds and equities. Yield spreads have been compressed, government bond markets have been very strong and are trading at historically very low yields, and all equity markets have been inflated broadly by this volume of cash.

“If fundamentally those higher valuations are not supported by better economic fundamentals then inevitably there’s more risk in markets.”

The markets’ reliance on ultra-loose central bank policy has been sharply brought into focus in recent weeks, after the suggestion that the Federal Reserve could look at slowing its $85bn-a-month QE programme led to a broad sell-off in the world’s stockmarkets.

Despite his caution over the short term, Woodford remains confident in his longer-term outlook for equities. The manager sees the eventual normalisation of monetary policy as starting in the US, but not for some time, which will ultimately address his concerns on inflated market valuations.

Woodford says: “Valuations have risen a long way. The challenge for markets will be in this transition phase from the extraordinary monetary policy that we have now, to a more normal monetary policy. I think this is a long way off in Europe and the UK and certainly a hell of a long way off in Japan.

“Ultimately a more normal economic environment, with more normal interest rates and a more normal relationship between the banks and the economy, I think will be good news for equity prices and good news for growth.”

Invesco Perpetual High Income’s cumulative performance to 11 June 2013

Invesco Perpetual High Income’s cumulative performance to 11 June 2013
 
Fund 3.80% 14.42% 23.63% 51.09% 48.28%
0.72% 11.15% 23.74% 42.44% 37.40%
3.06% 2.94% -0.09% 6.07% 7.92%
  4 / 99 15 / 98 49 / 98 17 / 89 15 / 75
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Source: FE Analytics