- The Fed's Daily U.S. Treasury purchases as part of QE have been the primary driver of stock market gains in the post crisis period.
- These daily U.S. Treasury purchases are being phased out and are set to end in October.
- What would the market have looked like without these daily U.S. Treasury purchases as part of QE and what are its implications for today's bull market.
The stock market is trading within 2% of its all-time peak reached at the beginning of April. And following an impressive bull market that recently entered its sixth year, it seems that the trauma that was the financial crisis is becoming a distant memory. Of course, the stock market did not achieve its miraculous recovery all on its own. Instead, it had the generous and ongoing support of the U.S. Federal Reserve for much of the journey to recovery through its daily asset purchases as part of its various quantitative easing (QE) stimulus programs. With all of this in mind, the experience of the last few years raises a worthwhile question to ponder. Exactly what would the markets have looked like without QE? Exploring the answer to this question is particularly worthwhile, as it provides important insights into what to expect from the stock market once the Fed ends its latest QE3 stimulus program in the coming months. More significantly, it may provide important insights into how exactly the current bull market may finally come to an end.
Since the outbreak of the financial crisis several years ago, the Fed has engaged in a variety of stimulus measures in order to help rescue the global economy and its markets from collapse. But the one program that has been particularly supportive of stock market gains more than any other has been the daily U.S. Treasury purchases that have accompanied the Fed's three QE programs. The details of these programs are shown below:
March 18, 2009 to March 31, 2010 - $300 billion in U.S. Treasury purchases
November 12, 2010 to June 30, 2011 - $600 billion in U.S. Treasury purchases
January 3, 2013 to Present - $680 billion in U.S. Treasury purchases to date
***Present to October 31, 2013 - A projected $100 billion more in U.S. Treasury purchases
In summary, the U.S. Federal Reserve has purchased $1.58 trillion in U.S. Treasuries over the last five plus years and will likely tack on at least another $100 billion in the coming months before the latest program is over. Viewing this differently, the Federal Reserve has printed into existence an amount in U.S. dollars that is equivalent to the annual GDP of Australia, which is the 15th largest economy in the world. In short, this is A LOT of money that the Fed has pumped into the system, and it has been having its effects.
To highlight how influential these daily U.S. Treasury purchases have been on U.S. stocks (NYSEARCA:SPY), it is worthwhile to dissect the market into two time periods. Both charts will begin when the Fed first began easing monetary policy with its first 50 basis point interest rate cut on September 18, 2007 and will continue through March 18, 2009 when the Fed first announced its intent to include daily U.S. Treasury purchases as part of its QE stimulus program. From there, the following differentiation between the two charts will be made.
The first will examine how the market has performed ONLY during periods when the Fed was NOT engaged in outright daily U.S. Treasury purchases as part of a QE stimulus program. This has been the case in 534 trading days since the Fed first began the outright daily purchase of U.S. Treasuries back in March 2009.
The second will examine how the market has performed ONLY when the Fed was engaged in daily U.S. Treasury purchases as part of a QE stimulus program. Such has been the case for 747 trading days since the Fed first began the outright daily purchase of U.S. Treasuries back in March 2009 including the last 325 trading days since the launch of QE3 at the beginning of 2013.
The contrast between these two market environments is notable.
The performance of the stock market WITHOUT daily U.S. Treasury purchases has been languid at best during the post crisis period. Notably, however, it has the look of a market that one would rationally expect in the wake of a major financial crisis, with stock prices undergoing an extended period of consolidation with several retests of the lows before entering into a phase of sluggish but gradual recovery at levels still well below the pre-financial crisis highs. Such a market would not only reflect an understandable degree of restraint and prudence among investors that have suffered sudden and considerable losses, but it would also better reflect many of the economic realities that have persisted in the post crisis period including most notably a housing market that remains at historical lows as measured by housing starts even after a modest recovery over the last several years and an unemployment rate that would still be stuck in the low double-digits if the labor force participation rate had been expanding at its normal historical rate during the post crisis period. The daily behavior of the market during these phases is also generally normal, with gains on 53.18% of trading days that is only slightly above the long-term historical average of 52.22%.
The performance of the stock market WITH daily U.S. Treasury purchases, on the other hand, has been in the stratosphere. Virtually all of the stock market gains during the post crisis period have occurred during phases when the Fed was actively engaged in U.S. Treasury purchases. And these gains have occurred with a notably steep slope and almost without any pause or hesitation along the way. Moreover, the daily performance of the stock market during these phases is far more robust with daily U.S. Treasury purchases with gains in 57.83% of trading days, which ranks among the best winning percentages in stock market history over historical time periods of comparable length.
The performance of stocks during these two distinctly different periods should be of critical importance to investors in the coming months. For the Fed's daily U.S. Treasury purchase program is dwindling fast, and with it will go what has been a profound driver of stock gains in the post crisis period. And while the stock market managed to trade sideways with elevated volatility during these phases without daily U.S. Treasury purchases, stocks were trading at much lower valuations then versus now. Perhaps more importantly, many of the downside corrections during these non-QE periods were reversed not by anything fundamental but instead by proclamations from the Fed that more daily U.S. Treasury purchases would soon be on their way. Looking ahead, the Fed may not be as quick to rush out and provide further support if stock prices start to sink. As a result, a volatile sideways pattern may be the best outcome investors should anticipate once QE3 has drawn to a close in the coming months. And investors should also be prepared for something altogether worse if it turns out that the Fed has decided enough is enough with daily U.S. Treasury purchases and it's time instead for the stock market to go it on its own as the Fed explores new ways to finally kick-start the still sluggish U.S. economy. Such are outcomes that would bring with them the end of the current bull market in stocks.
Disclaimer: This article is for information purposes only. There are risks involved with investing including loss of principal. Gerring Capital Partners makes no explicit or implicit guarantee with respect to performance or the outcome of any investment or projections made. There is no guarantee that the goals of the strategies discussed by Gerring Capital Partners will be met.
Additional disclosure: I am long stocks via the SPLV and XLU as well as selected individual stocks. I also have a meaningful allocation to cash at the present time.