Have Ben Bernanke's quantitative easing (QE) policies been responsible for inflating a stock market bubble, or at least bubbles in certain high-flying stocks?
The idea is that QE has pushed down the interest rates of bonds, and hence pushed the prices of bonds up. In turn, that has caused money to flow into stocks as investors search for higher yields. Lower interest rates should have one further consequence: They should discount the future less, resulting in growth companies becoming more valuable than before, whereas high dividend paying, slow growth companies, the reverse.
Has this actually happened?
Many commentators like to pick out what they consider to be stocks with ever-soaring valuations to demonstrate just that point. Here's an example of that. However, there are two problems with looking at things that way:
1. There are always overvalued stocks in the stock market, just as there are also undervalued stocks. I don't even believe that all the names mentioned in the article mentioned above are, in fact, overvalued.
2. The real flaw in the argument that blames QE for bubble valuations is that the stocks in question have kept on relentlessly going up since QE was announced. Yet the whole point of the stock market is that they are forward-looking and discount future events. An announcement of a certain level of quantitative easing should lead to a one-off re-rating of equities -- not a continuous rise in valuations as those stocks have experienced over the last year.
In other words, it doesn't matter that the Fed keeps on buying so many billions of dollars in bonds per month, only changes in the amount bought -- or guidance -- matter. The one exception to that would be if inflation was to take off, but as you can see in the chart below, inflation has stubbornly clung to the 2% level recently.
Click to enlarge images.
Now, I actually do think the stock market is overvalued. I just don't think QE has anything to do with it. The price-to-earnings multiple is around the historical average, as you can see in this chart:
However, earnings are at a record high. And the one thing we know about earnings is that they are mean reverting. If earnings fall over the next couple of years, then either the stock market will fall with it or P/E multiples must expand.
Below is a chart of earnings as a percentage of GDP over the last several decades. At 11% GDP, corporate profits are about twice the long-run average.
Now, why are corporate profits so high?
One reason is because the buoyant global economy accounts for an increasingly large share of U.S. corporations' sales and profits. The other reason is low-wage inflation in the United States over the last few years. This is almost certainly a function of the weak labor market we've had during the recovery from the 2008 recession -- something that Ben Bernanke, or at least the Fed, has to accept ultimate responsibility for.
So, ironically, it's precisely because the Fed hasn't been aggressive enough with its quantitative easing programs -- and its forward guidance policies -- that the stock market is as high as it is right now. Critics of Fed policy have accused it of inflating stock market valuations, but they're the ones venting hot air.