Perspectives

The Smart Bird – QE4 or Bust

The U.S. Department of Commerce Bureau of Economic Analysis has revised GDP for the last four years.  The average growth from 2011 – 2014 was revised down 0.3% to 2.1%, but most of the “previously understated” weakness came in 2013.  While it makes one wonder if three years from now 2015 GDP will be revised down, at least we now know why the stock market struggled so much in 2013.  Right?

2013 Revised Significantly Down

2013 Revised Significantly Down

We all know the stock market depends on the economy which is why the financial media reports the economic minutia on a daily basis.  So let’s see how highly correlated the stock market is to the performance of the US economy by looking at the annual returns of the GOV TSP funds as posted on the official Thrift Savings Plan website.

2013 Outperformed

2013 Outperformed

What a surprise, 2013 was by far the best year for the US stock market in 10 years even beating the 2009 bear market bounce back.  I know the stock market is a bit forward looking, but 2014 only grew 2.4%.  So how did that happen?

We all know the stated purpose of the Federal Reserve expanding its balance sheet by over 4 trillion dollars was to “create jobs” and propel the economy forward and not to repair the balance sheets of irresponsible too large to fail (or jail) banks.  But since the US economy continues to plod along under 2.5% growth, I wonder where the stimulus went.  Certainly not to re-inflated bubbles in financial assets like bonds, stocks and housing.

So where did all that QE go anyway

So where did all that QE go anyway

Hmmm,  I wonder why the stock market is so highly correlated to all the QE programs.

All QE programs were not the same.  If you look at the Fed’s own chart of the level of QE over the years, we see 2013 was a big beneficiary.  We also see 2009 got a strong dose.  I would even contend that the Fed’s purchase of Mortgage Backed Securities (Agency MBS) had a larger impact than Treasuries purchases.  While early 2014 still had significant stimulus in place by fall of 2014 the market’s life support was removed.  How did the stock market do?

Level of QE

Level of QE

In July of 2014 as the end of QE3 was insight, the broader market represented by the stocks listed on the NYSE started trading sideways and then gave way in October as the program ended.  On the same day QE3 ended, Japan’s Central Bank announced the expansion of their QE program and the US stock market bounced back but continued to trade sideways.  In March of 2015 the ECB started their own form of QE and the global markets pushed higher.

New York Stock Exchange

New York Stock Exchange

Some have commented how well the US markets have held up after the end of QE in the US, but we need to take into account global QE programs to a point.  That point may be ending soon.  Since QE did not propel the US economy to higher growth rates, the ratio of the stock market’s capitalization to GDP has expanded to double its long term mean value.  It is hard to imagine how the market will remain this levitated without additional QE let alone the raising of interest rates.

This week we are back to bad economic news is good news for the market.  Every bit of news that can be interpreted as pushing back the Federal Reserve raising rates is met with a short stock market rally.  The TSP S fund opened up over 1% today and the TSP C fund up over .75% on the negative job’s report.

“Stocks are rallying after ADP’s jobs report missed estimates”

If the best support the Federal Reserve can do today is not raise interest rates off zero, the markets could be in trouble and may begin to return to normal historical valuation levels.  And once the cycle turns in the markets, it usually proceeds rapidly and gives up much of the gains from the previous bull market regardless of monetary policy or corporate buybacks.  Smart investors profit from watching the markets for the signals that allow them to miss the next valuation reset – and it is not the economy.

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Categories: Perspectives