Why Neil Woodford Will Be Sticking To Fundamentals Despite QE In Europe

So folks, it’s finally here!  Quantitative easing (QE) but with a European flavour.  The European Central Bank has finally arrived at the party.  But what does Neil Woodford make of it all?

What is QE?

QE is simply a central bank putting some big numbers into a computer and buying government bonds.  As is the case when you take medication, there are side effects: from here, we should see asset prices rise as investors search for a better return than they are receiving on bonds; the Euro should weaken against other currencies, making European exports more attractive; and the banks should lend more to businesses.  As a result, the economy should grow and wealth should trickle down through the cracks into the masses.

Sadly, QE can often simply have the effect of making the select few rich.  Indeed, in his recent blog post ‘QE in an unequal world’, Neil Woodford presents a chart that shows the percentage of global wealth held by the top 1%  It currently stands at almost 50%  This figure has been rising since the low in 2009.

Sticking to fundamentals

In his blog, he argues that there are several reasons to be cautious:

“Firstly, past performance is not necessarily a guide to the future and there is good reason to believe that risk assets may ultimately behave differently this time.”

This statement is based on the fact that asset prices are not trading at low valuations, as was the case in 2009, and are much more ‘fully valued’ now.  Indeed, he argues “it is much more difficult for markets to move materially higher”, with asset prices at risk of earnings downgrades, and global stock markets are “pregnant with risk.”

Whilst indices have many constituents, I think he has a point and one should tread carefully, not getting carried away with the mood of the market — remember, the tide can raise all boats.  As we know, this can turn on a dime!

Still uncertainty with Greece

Whilst we currently have some breathing space, this issue is far from being put to bed.  Indeed, there will need to be further talks.  Woodford commented:

“Even if negotiations do conclude successfully, it is difficult to see how a compromise can provide a permanent solution to Greece’s problems whilst keeping the Germans happy at the same time.”

I think my main concern would be the fact that if Greece did exit, it could open the door for other indebted nations to follow suit.  Whether that happened or not, the fear of this event would cause panic in the markets.  I wouldn’t want to be holding an hyped-up stock — or index — in those circumstances.

The way forward

Whilst I don’t know Neil Woodford, I have read many of his interviews and I think that it is fair to say that his view on assets hasn’t changed.  He notes that: “I remain focused on identifying attractively valued businesses that I believe are capable of delivering long-term returns in spite of all the headwinds.”

I think that he should be commended for this, an approach that he has stuck to for as long as I have been following him.  Indeed, I try to look past the daily goings-on in the markets and, like Mr Woodford, I try to identify companies that should continue to prosper whatever the weather and share their profits with me with increasing dividends and share buybacks.