Sugar High No More? – From QE to QT

February 27, 2018 | Vito Finucci


The End of QE didn’t Hurt Markets, the start of QT won’t either.


“QE has been extraordinarily effective in boosting stock prices and the Fed is worried what happens when they stop. Restated, the bull market of the last 4+ years has a lot to do with FOMC stimulus. If history is any guide, its removal would be a profound negative for equity prices”


Respected Bond Analyst at Arbor Research, Jim Bianco


During the Great Recession of 2008-09, the US Federal Reserve under Chairman Ben Bernanke experimented with many “tricks” to keep the US economy on life support, but none were bigger than what has become known as “Quantitative Easing” or just “QE”. It was a huge experiment.


The US Federal Reserve on the week ending August 1st, 2007 (just before the start of the financial crisis) had assets on its books worth $858 Billion. At the end of 2009 that figure stood at 2.4 Trillion, and today stands at about $4.5 Trillion. A surreal amount. The Fed bought assets and printed cash like there was no tomorrow.


But they were not alone. Central banks around the world stimulated on steroids, with rates in Japan and Europe actually going negative.


Of course, many claim that much of the gains in markets were due to “QE”, so therefore as central banks begin to unwind their balance sheets, that markets should logically head in the opposite direction (i.e. lower) as they go into “Quantitative Tightening” (or “QT”).


The fact is, QE ended over three years ago, around late 2014. Since then, the US market is up another 40%. Since QE was first introduced, the S&P 500 has gained almost 1800 points. All but about 600 points were achieved during periods of QE. Of the remaining gain, 90% occurred after Trump’s victory when rates were actually rising.



After 35 years of one of the greatest bull markets that sent interest rates from almost 20% in the early 1980’s to near zero, it would appear the bull market for bonds is over. It’s simple. When interest rates rise, bonds lose value, it’s an inverse relationship. For every 1% increase in rates, a 10 year bond loses almost 4% and a 30 year almost 25% (Source: CMG Investment Research). I don’t think there are a lot of investors who realize this, mainly due to the fact that anyone who has bought a bond in the past 20 years, have ever experienced rising rates. They will do well again one day, probably in the next recession.


While the Fed’s policies have clearly helped push US equites higher, I do not believe to the extent portrayed. Since the US election in November, 2016, growth in consumption, lower taxes, investment, corporate profits, and just increased confidence have has an impact on where investors have placed their monies. During the Obama years, government loved to take credit for putting out fires that government started. It has become apparent the last 15 months or so, that the animal spirits were always present, just laying low and just waiting for a politically – friendly environment for Capitalism.


If one believes that “QE” saved the US economy, that belief then undermines faith in free markets and supports the premise that capitalism needs government’s guiding hand. I don’t happen to agree!


There are many who are using the recent market corrections to support the claim that the US economy is one big QE-driven “sugar high” bubble. But we haven’t had a decent pullback since the summer of 2016 and QE ended two years prior to that, so logic would dictate to me there are faults in that premise. The US 10 year Treasury sat at 1.90% on Election Day 2016, and didn’t get to the current 2.95% overnight. I don’t think that as rates approached 3% that investors went into a panic was a coincidence. It’s a round number and more and more is being written about rising inflation worries and that many believe the Fed is mow “behind the curve”. There are many reasons to believe the Fed could hike more than is built into markets, not least which are:

  1. The US economy is rolling along and picking up steam
  2. Inflation pressures are rising
  3. Financial conditions have gotten easier
  4. The Fed already has raised 4x in the past year
  5. The Fed doesn’t want stock markets to overheat
  6. US unemployment at all-time lows

And only a couple reasons why they might not raise rates as much as expected:

  1. Continued political dysfunction in Washington (shutdowns, debt ceilings, November midterms)
  2. A new sheriff is in town

I’d like to expand on #2. Last week was Janet Yellen’s last meeting as Chair of the Federal Reserve. She leaves with her legacy intact. One thing DC bureaucrats care about is legacy. Trump appointee Jerome Powell is now in the Chair. Whatever goes wrong now is his responsibility. I don’t think he wants to be the one who bursts the bubble and makes everything go south after 10 years of the Fed applying triage to the US economy.


When the Fed raises interest rates, they believe the economy is strong and can stand on its own merits. An analogy I always use, is when they raise rates it’s like taking the training wheels off. So maybe they will raise the three increases expected in 2018, maybe even a fourth, but if they do, the US economy will be humming.


Do higher rates mean a lower stock market? Not necessarily. If the Fed raises too much, eventually the economy will slow, it’s a fine line. The other part of that is that it usually takes 6 months for the moves to filter down through the economy. If the yield curve gets inverted (i.e. shorted rates get higher than long term rates) that would be the first warning sign.


So don’t believe the media pundits, what’s the actual history in rising rates? Last weekend a piece from the managing director and head of US equities at S&P Dow Jones, Jodie Gunzberg, who wrote:


“Since 1971, the S&P 500 has gained about 20% on average in rising rate periods, has gained 8 of 9 times, and has gained nearly 40% twice, with less than a 4% loss for its worst rate period”


I don’t believe markets are in a bubble. Rising corporate earnings, lower taxes, increased productivity, technology gains and just renewed confidence in a more business friendly political environment for capitalism have been the main drivers.


I DO believe there will be a lot more volatility, however. Of course, that doesn’t mean you can’t have a 10-12% pullback (like we recently experienced) or even 15%, 20% … but still in the context of an overall secular bull market which has years to go.


Stay tuned,


Vito Finucci, B.COMM, CIM, FCSI

Vice President and Director, Portfolio Manager


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