The End of Quantitative Easing and Future Stock Prices

Despite the recent rebound from last week’s market doldrums, it’s apparent this new bout of market volatility stems from future monetary policy decisions. The market is digesting the end of quantitative easing that appears to have been (at least partially) the fuel behind the markets upward ascent.

I thought this analysis from Zero Hedge clearly showed the effects of quantitative easing on the U.S. Equity Markets.  According to the analysis, the S&P 500 gained 1142.5 points under some type of QE implementation vs. a loss of 290.6 points when QE was absent. I have attached the graphic that the folks at Zero Hedge put together showing the actual performance of the S&P 500 during QE on – off periods.

 

While the effects of QE on economic growth may be beyond the parameters of this analysis, one thing seems clear. QE has had a positive effect on asset prices. Therefore it shouldn’t be surprising that the weaning process has brought some pain. During the highly volatile periods last week, one just needs to look at the headlines to understand the magnitude Fed influence.

 

 

 

Market commentary on market volatility and “Fed Speak”

MARKETS GO WILD AFTER THE FED SAVES THE DAY: Here's What You Need To Know – Business Insider

It Took Just 2 Sentences From The Fed To Make The Stock Market Go Wild – Business Insider

The Fed Comes To The Rescue – Business Insider

‘Plunge protection’ behind market’s sudden recovery – New York Post

Going back to the wonderful research done by Zero Hedge, the attached graphics reiterate the belief that Fed intervention in the form of QE has had a direct impact on asset prices but perhaps the most interesting point in this analysis claims, “For over a year now, central banks have quietly being reducing their support. As Figure 7 shows, much of this is down to the Fed, but the contraction in the ECB’s balance sheet has also been significant. Seen from this perspective, a negative reaction in markets was long overdue: very roughly, the charts suggest that zero stimulus would be consistent with 50bp widening in investment grade, or a little over a ten percent quarterly drop in equities. Put differently, it takes around $200bn per quarter just to keep markets from selling off.”

 

 

 

 

 

 

“If anyone ever needed any confirmation of what we said in June 2012, that "The Stock Is Dead, Long-Live The Flow: Perpetual QE Has Arrived", now you have it, and only qualified but quantified. Because to translate what Matt King - Citi's most respected strategist and the only person on Wall Street to warn about the Lehman collapse and its consequences before it happened, just said - if and when the global central bank liquidity tracker ever drops to $200 billion per quarter or less, the market will crash.”

I would definitely encourage all to read this analysis in its entirety:

The Magic Number Is Revealed: It Costs Central Banks $200 Billion Per Quarter To Avoid A Market Crash – Zero Hedge

So what’s the next move for the Fed?

I’m not sure who coined the term, but I think Priya Misra from BofA wrote (via Business Insider) the Fed will now partake in “verbal easing”. The notion behind verbal easing states that while the Fed may continue their QE tapering process, they will use other means such as speeches and other communication to better prepare equity markets for the inevitable departure of QE while at the same time assuring the markets that they are prepared to keep rates low for a long time.

Indeed we have seen several Fed officials hitting the speaking circuit as Charles Evans, President of the Federal Reserve Bank of Chicago reiterating the patience the Fed should exhibit when raising rates. U.S. Federal Reserve Vice Chair Stanley Fischer reiterating the timing of the next rate increase will be dependent on the strength of the economy and John Williams, President of the Federal Reserve Bank of San Francisco not ruling out another round of QE if necessary.

Bottom Line: While the flow of dovish commentary has helped stem market losses, one needs to accept the fact that QE is going away. Our opinion, barring some unforeseen economic or geopolitical event, is that another round of QE is unlikely. Therefore we anticipate more market volatility and still anticipate additional downside in the near-term. That said, we also believe that the U.S. economy will prove to be able to support itself once QE is gone. Our anticipation of a corrective period should offer excellent buying opportunities as value creeps back into the market.

 

Joseph S. Kalinowski, CFA

 Suggested Readings

Federal Reserve’s Low Interest Rates Enable Washington’s Dysfunctions - Breitbart

FED'S FISCHER: The Markets Have It 'More Or Less Right' – Business Insider

FED'S EVANS: 'We Should Be Exceptionally Patient' – Business Insider

FED'S WILLIAMS: More QE Could End Up Being Necessary – Business Insider

 

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