QE II Has Had a Positive Effect on the Market

Stocks keep rising though the June end of policy looms

   

On Sept. 24, 2010, David Tepper, founder of the $12.4 billion Appaloosa Management hedge fund, said on CNBC that the market would be heading higher on the back of Quantitative Easing II or on an improving economy — a no-lose situation for stocks. Since that pronouncement, that’s what the market has done.

Tepper’s forecast shouldn’t have come as a surprise. Prior to his QEII remarks, that’s all the market had done with QEI. The only time the market took a breather was from the end of April until the end of August 2010, which is when the Fed took a breather between QEI and QEII.

The first chart below is of the S&P 500 Index Options (CBOE: SPX) index. Compare this chart with the timing of the asset side of the Fed’s balance sheet expanding from the QE programs, shown in the second chart below.

SPX1 QE II Has Had a Positive Effect on the Market

S&P 500 Index Options "SPX"

 

QEIIA QE II Has Had a Positive Effect on the Market

Quantitative Easing I & II Comparison

 

The chart titled “QE I and QE II” shows how the Fed expanded the asset side of its balance sheet from about $495 million of assets held outright at the start of 2009 to $2.3 billion worth of assets held today. The two lines on the chart may be confusing. The key line is the blue line, which shows total assets held by the Fed. The rise in slope of this line shows both QEI and QEII. The flat slope shown from March 2010 to September 2010 shows the Fed in a “non-accumulation” period between the end of QEI and the start of QEII, which tightly fits with the market’s troubles during summer 2010.

By including the red line, which shows the Treasury purchases by the Fed, we capture the character of and differences between QEI and QEII. QEI was all about the Fed buying troubled assets from banks — mostly mortgage-backed securities. Total assets held by the Fed expanded primarily because of mortgage-security buying rather than Treasury-security buying. QEII is all about buying U.S. Treasuries. During QEII, the red and blue lines have the same slope.

With the Fed wanting asset prices to rise — and being determined to stick with QEII through June — having the market be a slave to the Fed may not be so bad for a few more months.

How will the market respond when the Fed terminates QEII in June and this slavish relationship of rising Fed assets with a rising stock market is interrupted? The market seems to be comfortable with the thought that either there will be a QEIII or that the economy will have gained sufficient velocity as to not require further Fed stimulation. As we approach the end of QEII, the expected market reaction increasingly will become the subject of speculation, which finally may give investors a buying opportunity before the next leg of the advance.

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Article printed from InvestorPlace Media, http://investorplace.com/2011/03/qe-ii-has-had-a-positive-effect-on-the-market/.

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