All QEs Are Not Created Equal

by: Evariste Lefeuvre

Operation Twist is supposed to end in June. Expectations on a forthcoming QE3 are still mixed, but the odds of it happening are increasing as the economy shows signs of deceleration.

The rational is not always clear and the timing is sometimes questionable. As can be seen on the chart below, Fed quantitative easing waves always started with a lag in comparison with economic momentum.

As the impact of GDP growth has always been questionable (for example, a weaker USD spurred higher oil prices playing havoc on households' purchasing power), an effect on equity markets seems unquestionable. Are all QE created equal, though?

The table below summarizes QEs and Operation Twist. I designed an "efficiency adjusted" ratio (the SP 500 return divided by the share of the Fed's balance sheet implied). It is kind of a monetary sharp ratio as it assess the stock market return in comparison with the share of the Fed's balance sheet that has been involved.

Operation Twist had the highest rate. The worst result came from QE2, even though it involved a huge chunk of the balance sheet and was implemented after the mildest of the last three troughs.

Click to enlarge.

Click to enlarge

This confirms that size doesn't matter. It also highlights that there is not such a thing as a declining marginal productivity of QE. Any unconventional QE should try to remain balance sheet neutral. I am not advocating QE3, but should the Fed decide to implement it, the best option will be a second twist, not a third QE.

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.