A Brief History Of QE In The U.S.: Focus On Mid-Caps Via MDY

| About: SPDR S&P (MDY)

Summary

Assets on the balance sheet of the U.S. Federal Reserve have almost quintupled since it launched quantitative easing, or QE, in September 2008.

During this period, the level of its holdings advanced to $4.49 trillion from $925.73 billion, an increase of $3.56 trillion, or 384.67 percent.

Over the same time, MDY climbed to $258.12 from $134.23, a hike of $123.89, or 92.30 percent, on an adjusted closing weekly share-price basis.

The Federal Reserve has carried out large-scale asset purchases under so-called quantitative-easing programs during two eras since the central bank was created in December 1913. The first QE era began in 1932, arguably the low point of the Great Depression: Aspects of this period are covered by a Economic Synopses essay published by the Federal Reserve Bank of St. Louis in 2010. The second QE era started in 2008, arguably the low point of the Great Recession: Aspects of this period are covered by this article and the previously published "A Brief History Of QE In The U.S.: Focus On Large-Caps Via SPY."

Because of the character of my financial-market participation, I will most finely focus here on the historical relationship between the level of assets on the consolidated Federal Reserve Bank, or FRB, balance sheet and the adjusted closing weekly share price of the SPDR S&P MidCap 400 ETF (NYSEARCA:MDY) since the exchange-traded fund hit its first major trough of the 21st century. Basically, I propose to answer three questions:

  • Does evidence indicate a causal relationship between the level of FRB assets and the share price of MDY since 2008?
  • Assuming such evidence exists, does it suggest the planned static level of FRB assets in coming months will have an effect on the contour of MDY's future path?
  • Again assuming such evidence exists, does it suggest FRB assets have comparatively more effect on the large-capitalization SPDR S&P 500 ETF (NYSEARCA:SPY) or on the mid-cap MDY?

Figure 1: FRB Assets And MDY, March 3, 2003-Oct. 27, 2014

Notes: 1. Baseline "March 3, 2003" chart data encompass the period between March 3 and March 7 of that year. 2. The FRB assets (whose scale is on the left side) and MDY share price (whose scale is on the right side) are presented here as they were on the Fridays of all reported weeks.

Source: This J.J.'s Risky Business chart is based on All Federal Reserve Banks-Total Assets, Eliminations from Consolidation, or WALCL, data at the Federal Reserve Economic Data, or FRED, site hosted by the Federal Reserve Bank of St. Louis and MDY adjusted closing weekly share prices at Yahoo Finance.

The Federal Reserve balance-sheet expansion induced by the precursor of its three formal QE programs got under way with a bang Sept. 15, 2008, when Lehman Brothers Holdings Inc. filed for protection under Chapter 11 of the U.S. Bankruptcy Code, as indicated by FRED's aggregation of the central bank's data in its weekly statistical series "H.4.1 Factors Affecting Reserve Balances of Depository Institutions and Condition Statement of Federal Reserve Banks" (Figure 1).

The above-charted 609-week interval comprises two discrete periods on either side of the Lehman Brothers bankruptcy filing date: Aka the Non-QE Era, the first consists of 289 weeks; aka the QE Era, the second consists of 320 weeks. Below is comparative information related to the two periods:

  • In the Non-QE Era, FRB assets grew at a slow pace to $925.73 billion from $722.65 billion, an increase of $203.08 billion, or 28.10 percent, while MDY progressed to $134.23 from $63.98, a yield of $70.25, or 109.80 percent. Accordingly, FRB assets and MDY rose by weekly means of 0.10 percent and 0.38 percent, in that order.
  • In the QE Era, FRB assets grew at a fast pace to $4.49 trillion from $925.73 billion, an increase of $3.56 trillion, or 384.67 percent, while MDY progressed to $258.12 from $134.23, a yield of $123.89, or 92.30 percent. As a result, FRB assets and MDY rose by weekly means of 1.20 percent and 0.29 percent, respectively.

Figure 2: FRB Assets And MDY, Sept. 8, 2008-Nov. 17, 2008

Notes: 1. Baseline "Sept. 8, 2008" chart data encompass the period between Sept. 8 and Sept. 12 of that year. 2. The FRB assets (whose scale is on the left side) and MDY share price (whose scale is on the right side) are presented here as they were on the Fridays of all reported weeks.

Source: This J.J.'s Risky Business chart is based on WALCL data at the FRED site and MDY adjusted closing weekly share prices at Yahoo Finance.

The Federal Reserve balance sheet expanded at its fastest pace before the Federal Open Market Committee even announced the first of its three formal QE Era programs Nov. 25, 2008. Assessing this era, I have identified four discrete periods, with dates of the relevant weeks as follow:

  • Age of QE0: Sept. 8, 2008-Nov. 17, 2008.
  • Age of QE1+: Nov. 17, 2008-Oct. 25, 2010.
  • Age of QE2+: Oct. 25, 2010-Sept. 4, 2012.
  • Age of QE3+: Sept. 4, 2012. (The Fed has concluded its asset purchases under the QE3+ program, but I will consider this age history only when the FOMC announces either QE4 or a credible plan to shrink its balance sheet. I anticipate the former may happen by Election Day 2016, and I expect the latter might happen long after I have kicked the bucket.)

During the 10 weeks of the Age of QE0, FRB assets more than doubled, to $2.19 trillion from $925.73 billion, an amazing gain of $1.26 trillion, or 136.26 percent, while MDY was trimmed by more than two-fifths, to $73.94 from $134.23, an equally amazing loss of -$60.29, or -44.92 percent (Figure 2). Therefore, FRB assets rose by a stunning weekly mean of 13.63 percent, and MDY fell by an equally stunning weekly mean of -4.49 percent.

Given the crisis conditions in the economy and the extreme volatility in the financial markets at the time, I believe there is no evidence of either a positive or a negative causal relationship between FRB assets and MDY to be discovered lurking in the data associated with the Age of QE0.

Figure 3: FRB Assets And MDY, Nov. 17, 2008-Oct. 25, 2010

Notes: 1. Baseline "Nov. 17, 2008" chart data encompass the period between Nov. 17 and Nov. 21 of that year. 2. The FRB assets (whose scale is on the left side) and MDY share price (whose scale is on the right side) are presented here as they were on the Fridays of all reported weeks.

Source: This J.J.'s Risky Business chart is based on WALCL data at the FRED site and MDY adjusted closing weekly share prices at Yahoo Finance.

The FOMC made three key announcements associated with the Federal Reserve balance sheet during the Age of QE1+, as follow:

  • Nov. 25, 2008: It announced the closed-ended QE1 program, authorizing $600 billion in asset purchases, consisting of $500 billion in agency mortgage-backed securities and $100 billion in government-sponsored enterprise debt securities.
  • March 18, 2009: It almost tripled the size of its program as it announced QE1+, authorizing $1.75 trillion in asset purchases, consisting of $1.25 trillion in agency MBS, $300 billion in U.S. Treasury securities and $200 billion in GSE debt securities.
  • March 16, 2010: It announced the completion of QE1+ program purchases.

Over the 101 weeks of the Age of QE1+, FRB assets expanded to $2.30 trillion from $2.19 trillion, a relatively small inflation of $108.26 billion, or 4.95 percent, while MDY expanded to $143.93 from $73.94, an absolutely large inflation of $69.99, or 94.66 percent (Figure 3). Thus, FRB assets and MDY swelled by weekly means of 0.05 percent and 0.94 percent, in that order.

Essentially, the Fed's balance sheet during this period reflected a swap of assets with short-term maturities purchased on an emergency basis under QE0 for assets with long-term maturities purchased on a nonemergency basis under QE1+. For example, the Fed held $0 in agency MBS Nov. 19, 2008, and $1.07 trillion in such securities Oct. 21, 2010.

The U.S. government's fiscal stimulus complemented the central bank's monetary stimulus over the Age of QE1+, but I still think there is evidence of a causal relationship between FRB assets and MDY to be found in the relevant data. As the chart indicates, the ETF took a header after the Fed completed its purchases under the program.

Figure 4: FRB Assets And MDY, Oct. 25, 2010-Sept. 4, 2012

Notes: 1. Baseline "Oct. 25, 2010" chart data encompass the period between Oct. 25 and Oct. 29 of that year. 2. The FRB assets (whose scale is on the left side) and MDY share price (whose scale is on the right side) are presented here as they were on the Fridays of all reported weeks.

Source: This J.J.'s Risky Business chart is based on WALCL data at the FRED site and MDY adjusted closing weekly share prices at Yahoo Finance.

The FOMC made three key announcements associated with the Federal Reserve balance sheet during the Age of QE2+, as follow:

  • Nov. 3, 2010: It announces the closed-ended QE2 program, authorizing $600 billion for the purchases of U.S. Treasury securities.
  • June 22, 2011: It announced the completion of QE2 program purchases.
  • Sept. 21, 2011: It announced Operation Twist II, authorizing the extension of the average maturity of assets on its balance sheet, meaning it replaced short-term securities with long-term securities.

During the 97 weeks of the Age of QE2+, FRB assets advanced to $2.82 trillion from $2.30 trillion, a gain of $526.78 billion, or 22.95 percent, while MDY advanced to $178.40 from $143.93, a gain of $34.47, or 23.95 percent (Figure 4). Accordingly, FRB assets and MDY grew by weekly means of 0.24 percent and 0.25 percent, respectively.

The Age of QE2+ appears to offer strong evidence of a causal relationship between FRB assets and MDY, especially given the sequence of events associated with the ETF's bear market in 2011: On an intraday basis, MDY hit its peak of $184.97 May 2 (about seven weeks before the announced end of QE2 program purchases), and it hit its trough of $132.94 Oct. 4 (about two weeks after the announced beginning of Operation Twist II). Without being powered by the fuel of the Fed's balance sheet during a comparatively short period that year, the ETF shed $52.03, or 28.13 percent.

Figure 5: FRB Assets And MDY, Sept. 4, 2012-Oct. 27, 2014

Notes: 1. Baseline "Sept. 4, 2012" chart data encompass the period between Sept. 4 and Sept. 7 of that year. 2. The FRB assets (whose scale is on the left side) and MDY share price (whose scale is on the right side) are presented here as they were on the Fridays of all reported weeks.

Source: This J.J.'s Risky Business chart is based on WALCL data at the FRED site and MDY adjusted closing weekly share prices at Yahoo Finance.

The FOMC made four key announcements associated with the Federal Reserve balance sheet during the Age of QE3+, as follow:

  • Sept. 13, 2012: It announced the open-ended QE3 program, authorizing $40 billion per month for the purchases of agency MBS.
  • Dec. 12, 2012: It more than doubled the size of its program as it announced QE3+, authorizing $85 billion per month in asset purchases, consisting of $45 billion per month in U.S. Treasury securities and $40 billion per month in agency MBS.
  • Dec. 18, 2013: It announced the beginning of the QE3+ program's so-called taper.
  • Oct. 29, 2014: It announced the end of the QE3+ program's purchases.

Over the 112 weeks of the Age of QE3+ (starting Sept. 4, 2012, and finishing Oct. 27, 2014, for this article's purpose), FRB assets rocketed to $4.49 trillion from $2.82 trillion, an increase of $1.66 trillion, or 58.98 percent, while MDY similarly rocketed to $258.12 from $178.40, an increase of $79.72, or 44.69 percent (Figure 5). As a result, FRB assets and MDY rose by weekly means of 0.53 percent and 0.40 percent, in that order.

The Age of QE3+'s books are not closed yet, but it seems to have provided strong evidence of a causal relationship between FRB assets and MDY.

Figure 6: FRB Assets, MDY And SPY Weekly Mean Changes

Source: This J.J.'s Risky Business chart is based on WALCL data at the FRED site, as well as MDY and SPY adjusted closing weekly share prices at Yahoo Finance.

Mind-blowing is the best word, hyphenated or unhyphenated, for the above chart (Figure 6), which compares the Non-QE Era (289 weeks) and QE Era (320 weeks) by way of the weekly mean change by percentage in the level of FRB assets and the share prices of MDY, a proxy for mid-cap equities, and SPY, a proxy for large-cap stocks.

Because of the disparity in sizes, the chart columns associated with FRB assets are the most arresting at first glance, as a 12-to-1 ratio is pretty attention-getting in any form. However, the columns related to the share prices of MDY and SPY may tell an even more interesting story to me as a financial-market participant.

Among other things, the data indicate MDY overperformed SPY by a weekly mean of 15 basis points in the Non-QE Era, but of just 3 basis points in the QE Era. This behavioral compression is consistent with the almost-perfect positive correlation between the two ETFs from Sept. 12, 2012, to March 7, 2014, reported in "SPY, MDY And IJR At The Fed's QE3+ Market Top." Once the Wall Street winds begin to blow, the data suggest neither mid-caps nor large-caps will furnish perfectly safe havens.

And the evidence of a causal relationship between FRB assets on the one hand and both ETFs' share prices on the other hand is strong enough for me to be looking for those very winds more intently now than at any other time since the conclusion of the Fed's asset-purchase program in mid-2011.

Disclaimer: The opinions expressed herein by the author do not constitute an investment recommendation, and they are unsuitable for employment in the making of investment decisions. The opinions expressed herein address only certain aspects of potential investment in any securities and cannot substitute for comprehensive investment analysis. The opinions expressed herein are based on an incomplete set of information, illustrative in nature, and limited in scope. In addition, the opinions expressed herein reflect the author's best judgment as of the date of publication, and they are subject to change without notice.

Disclosure: The author has no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.

The author wrote this article themselves, and it expresses their own opinions. The author is not receiving compensation for it (other than from Seeking Alpha). The author has no business relationship with any company whose stock is mentioned in this article.

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