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By all accounts, the Federal Reserve is about to pull the plug on quantitative easing. If true, it would mark the end of a golden age for U.S. stocks.
The Fed enacted its bond-buying program, a.k.a. quantitative easing, way back in November 2008 at the height of the worst recession since the Great Depression. The monthly bond purchases were intended to jumpstart the ailing economy. The impact on the stock market has perhaps been even more profound.
The three rounds of quantitative easing have played a major role in helping stocks ascend from their lowest point in more than a decade to all-time highs. Just look at how the S&P 500 has performed during periods of quantitative easing the last six years:
Notice a trend? What’s just as interesting as how high stocks have risen during times of quantitative easing is how flat – or at times, down – stocks have been when the Fed wasn’t buying back bonds.
It’s a striking visual. But let’s dig deeper and look at the actual numbers. Here’s how the S&P has performed in the quantitative easing era:
QE1: +36.4%
Between QE1 and QE2 (April 1, 2010 – Nov. 2, 2010): +1.3%
QE2: +10.6%
Between QE2 and QE3 (July 1, 2011 – Sept. 17, 2012): +9.1%
QE3: +32.5%
Doing the math, stocks have risen a total of 79.5% during quantitative easing, or an average of close to 20% a year. During the two periods between bond buybacks, stocks rose a mere 10.4% – or less than 5% a year.
No wonder investors panicked a bit when Ben Bernanke first said the Fed would be “tapering” back its bond-buying efforts from $85 billion a month. Interestingly enough, since the Fed actually did start winding down QE3 under Bernanke’s successor Janet Yellen, it has done little to slow stocks down.
So what will happen when the Fed does finally pull the plug on QE3 – whether it happens next week or next month? Will stocks slow down the way they did between previous rounds of quantitative easing? Or is the U.S. economy now strong enough to stand on its own two feet?
The Fed is obviously hoping for the latter. That’s why they’ve allowed QE3 to drag on for more than two years. They didn’t want to pull the plug on the bond-buying program until they were sure that the threat of a double-dip recession had been avoided.
The artificial inflation of $85 billion per month being pumped back into the economy has sent stocks to places never before seen. The Fed is confident that the U.S. economy can stand on its own two feet. But can the stock market?
We’ll know soon enough. The fact that stocks have continued to rise even as the Fed has whittled its bond buying down from $85 billion to $15 billion is certainly encouraging.
If the Fed pulls the plug on QE3 in the next month or so, it could actually be perfect timing with the holidays right around the corner. Another booming shopping season could make investors easily forget that billions of dollars are no longer being pumped back into the economy. Of course, once the calendar flips to January, we’ll get the true gauge of how Wall Street is responding to the end of QE3.
We hope the absence of panic during the Fed’s recent monthly “tapering” is a sign of things to come.
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