Quantitative easing (“QE”) has been a term used in investors' vocabulary since January ’09, when the first round of QE (“QE 1.0”) was introduced.
On March 18, 2009, QE 1.0 was expanded to purchasing $300 billion of treasuries from primary dealers. It should be no surprise this date was almost exactly where the markets had bottomed. QE has played the role of upside catalyst to our markets at the expense of our currency ever since.
From the first round of QE taken in 2009, primary dealers have since benefited from approximately $2.77 Trillion in stimulus, which averages to a status quo of $85 billion per month over the 32 month period. This is historical average does not take into account that some months QE was $0 and others it averaged $123 billion. Nevertheless, this average does create a baseline scenario of what the minimum requirements for QE 3.0 will need to add up to.
Currently QE “Lite,” announced on August 10, 2010, is still contributing approximately $35 billion per month of stimulus to primary dealers’ balance sheets. Simple math tells us that QE 3.0 would need to be at least on average an additional $50 billion of purchases per month. Extrapolate 12 months, and we have another $600 billion of QE, bare minimum. However, simple math does not tell the whole story.
Digging deeper, I compared the monthly returns of the S&P 500 vs. the total amount QE the Fed injected during the same period:
For the months QE operations totaled greater than $100 billion, the S&P 500 returned a staggering 59.5% cumulatively. On the contrary, when QE operations totaled less than $100 billion for the month, the markets lost -19.24% cumulatively.
If one were to have created a simple buy/sell trading model off of the data, where they bought the S&P when QE operations totaled greater than $100 billion, and sold the S&P when operations were less than $100 billion, they would have been right more than 71% of the time. These are great odds for such a simple trading system when considering the cumulative returns of winners vs. losers.
It is worth noting that the second period of $100+ billion buying from November ’10-June ’11 was not nearly as consistent in supporting markets as it was during the March ’09 to March ’10 period. From March’09-’10 QE successfully pushed markets higher 11 out of 13 months (85%). During the November’10-June’11 period, markets were higher only 4 out of 8 months (50%).
When considering the half-lives of QE programs and the shortening impact they have had, QE3 will have to be bigger than previous renditions. It is important to put into perspective that QE 1.0 of $40 billion a month is now roughly the size of QE Lite ($35B). QE 2.0 was 88% larger on a monthly basis than QE 1.0, and was 100% larger in total size.
My baseline $50 billion a month QE3 will not be anywhere accommodative enough to support an upside catalyst thesis for this market.
To get the same “punch” as QE 1.0 and 2.0, which many view as failures, I now estimate QE3 will have to purchase $1.35-1.665 trillion within a year. This estimate takes QE 2.0 as a baseline (~$75B a month), considers the logic discussed above, and expands the scope by 50-85%. That’s somewhere between an additional $112.5-138.75 billion per month on top of the steady $35 billion QE Lite is contributing. Anything less should be viewed as a disappointment.
Stay tuned for parts 2 and 3:
- Quantifying QE3: Should The Fed own more Treasuries?
- Quantifying QE3: What will happen to the USD if QE3 is on?
Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.