From Mr Kevin Tanner.
Sir, As a “fundamental investor” of long standing, I appreciated Paul Woolley’s analysis of momentum trading and the risks it brings to equities markets (“A long-term battle to drive out short-term investment risk”, Insight, Markets & Investing, March 14). Yet he missed a major aspect of the problem and a relatively straightforward solution.
Mr Woolley failed to identify the waves of liquidity being created by central banks today, known collectively as quantitative easing, as the paramount force underlying momentum trading. In the US, for example, Ben Bernanke, chairman of the Federal Reserve, believes QE fuels a “wealth effect” by pumping up asset prices that will spur the broader economy forward. Since 2010, in fact, gains on the stock market have been very highly correlated with the Fed’s permanent open market operations (Pomo), the mechanism for implementing QE. The record is one of manufactured liquidity passing through banks instantaneously to “risk-on” assets traded primarily by speculators.
Rather than adding to the regulatory superstructure with closer monitoring and the creation of new risk metrics, as Mr Woolley suggests, a far simpler solution to runaway short-termism lies in the tax codes. Imagine a tiered capital gains tax structure in which short-term (a millisecond to 364 days), medium-term (one to five years) and long-term (five years and beyond) gains were treated differently, with the longest holding periods enjoying far lower (or even no) tax exposure. That would keep derivatives in check, reduce portfolio turnover and push “risk-on”-type trading strategies soundly out of favour.
In response, retail and professional investors alike would seek appropriately priced companies with strong balance sheets, smart leaders and enduring competitive advantages. That is the wealth effect we want: investment flowing to companies based on their long track records of success and trading on stock exchanges we can again trust.
Kevin Tanner, Founder and Chief Investment Officer, Saratoga Research and Investment Management, Saratoga, CA, US
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