Second thoughts on QE

It has become the received wisdom that quantitative easing (QE) has played a central role in pushing up asset prices in recent years. That makes it a particularly good time to question the contention.

Many commentators, including myself, have gone on to argue that QE has favoured the rich disproportionately since they hold most financial assets. Robert Frank, an expert on America’s super-rich, even claimed recently that: “Every Ferrari dealership in the country should have a framed picture of Ben Bernanke in their lobby. It should read: ‘Our #1 Salesman’.”

But perhaps the fundamental premise, that QE has bolstered asset prices, is exaggerated? This possibility merits closer scrutiny.

The announcement of the start of tapering by America’s Federal Reserve makes such re-examination even more opportune. As the rate of QE is gradually reduced (and it is important to remember it is merely a reduction in the rate of expansion) the impact on asset prices of this shift will be watched closely.

There is little doubt about the impact of QE on the fixed income markets since its advent in late 2008. Central banks have helped push bond prices up, and therefore yields down, by buying bonds directly.

But in relation to stockmarkets the case is murkier. Since central banks have not bought equities it becomes a matter of trying to assess the indirect effects. QE has certainly boosted liquidity but that alone gives no indication of the extent to which it has bolstered equity prices.

Lars Kreckel, an equity strategist at Legal & General Investment Management, accepts that the rise of the S&P 500 since its 2009 trough has showed some correlation with the growth of the Fed’s balance sheet. However, he argues that earnings growth provides a more compelling explanation of long-term equity performance. If anything the S&P 500’s rise would have been even greater if QE had been the main driver.

Multiple expansion – an increase in the ratio of prices to earnings – has also in his view played a significant role. Kreckel estimates that of the 150 per cent increase since the 2009 low about two-thirds can be accounted for by earnings growth and about a third by multiple expansion.

Nor are current valuations exceptional by historical standards. The LGIM strategist argues that equities have typically yielded positive returns from current levels although there are exceptions such as the 1880s and the Great Depression of the 1930s. He also points out that dividends have increased by 85 per cent since their recessionary trough.

Kreckel acknowledges that QE has played some role in increasing equity prices by bolstering liquidity. But he points to several other reasons why investors would find the environment less risky than before including the stabilisation of the eurozone and reduced fears of a Chinese hard landing.

Despite Kreckel’s observations it seems clear both that QE has helped bolster asset prices since 2009 and that the rich have benefitted disproportionately from this trend.

The point of contention is whether QE has been the predominant force in relation to the upward surge in equities in particular.

By reminding others that there are other forces at play besides QE he has helped clear the way for a more rounded examination of the topic.

This comment was first published today on Fundweb.