When will the Fed taper its purchases of Treasuries and
mortgage backed securities as part of its Quantitative Easing? That seems to be the biggest discussion going
on at all the hottest clubs. The chief economist from my favorite econ
research team (Goldman) said “A September tapering is certainly possible”.
In an economic sense, QE is more debated than JB at the Heat Game
7. Regardless of whether QE
works, is destructive long-term, neither, or both, I want to focus on its
impact on equity markets where I see 3 common reasons why it’s bullish:
- Higher earnings of companies through refinancing as interest rates are pushed down.
- Low bond yields force investors into higher yielding assets (e.g. stocks), which in turn forces up stock prices and valuations.
- QE creates liquidity (e.g. I hold a bond, the Fed buys it, I now have cash), which has to be put somewhere. One of those places is the equity market.
Ipso
facto, QE tapering would be bearish for equities. I do believe that is a risk, but at least for
now under the current facts and circumstances – facts and circumstances
which can and do change – I am less concerned, and here is why:
- Econ Data Still Not There: from the same article “I think that is going to depend on the data… Chairman Ben S. Bernanke expresses caution over trimming the program too soon… The likelihood that the economy will continue to grow about 2 percent over the next couple of quarters with inflation ‘well below’ target will probably stay the Fed’s hand until December”.
- Closer to End of Recovery Cycle: Cullen Roche at Pragmatic Capitalist elaborates on the last bullet: we’re in the backstretch of the recovery, unemployment is still way too high, corporate revenues are starting to falter.
- Tapering Not Huge Anyway: if they do taper, consensus isn’t exactly a large change to the Fed’s balance sheet.
- Good Economic News Drives This Decision: as insinuated earlier, if the Fed is tapering then economic data is good. If economic data is good, then stocks should do well.
That
last bullet is the key. If economic data
falters as the Fed tapers their purchases then equity markets will be in
trouble. A good article at Learning Bonds points out that
fact QE and equity prices is even a conversation points to artificially
inflated equity values. Thus, if data
comes in weak stocks would be more likely to revert to their fundamental
value.
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