Over the past year or so, I've continually made the claim that QE and Operation Twist would have little impact on the broader economy aside from pushing investors further out on the risk curve. Despite being correct in that view, the persistent bullishness within US equity markets has been surprising. Taking a different approach by looking at market internals, Microfundy offers a new perspective on how QE Failed.
Mario Draghi's infamous speech on July 26th hinted at more asset purchasing/easing causing the markets to roar higher. As you can assume, taking a look at the internals of that two day rally, you would see out-performance by the high yielding blue chips. THIS WAS NOT A GOOD RALLY! It's akin to EPS growing via cost cutting. I don't care if the S&P goes to 2,000 by year end, if it is led higher by XLU & XLP, that's telling me that it is a QE fueled rally that is not being sustained by growth or a economic recovery etc. It is being caused by the powerful "hunt for yield", and the unfortunate belief & wager that we are Japan! That is not a rally to be celebrated, because just like cost cutting… it's unsustainable!
The analogy between effects of QE and cost cutting, in particular, caught my attention. Since the market peaked in mid-'07, earnings per share of the S&P 500 (SPY) have grown over 50% despite sales per share only growing by ~3%.
While QE has generated a "hunt for yield", cost cutting has also been providing a significant tailwind for stocks over the past few years. Extending the time range a bit further shows that the market has generally been nearing its peak when earnings diverge upwards from sales.
Growth from cost cutting and lower yields appear to be reaching their limits just as revenue growth turns south. Without these tailwinds for earnings and multiple expansion continuing, the market is probably much closer to an interim top than bottom. Whether or not earnings will witness a precipitous drop similar to '08 remains to be seen and likely hinges on the future stance of fiscal policy (in the US, Europe and China). Regardless, patience remains warranted as far better entry points to the market will present themselves in the next few years.