The end of QE is the end of the world as we’ve known it since the crash, but it’s not the end of the world.
This article is part of a regular series of thought leadership pieces from some of the more influential ETF strategists in the money management industry. Today’s article is by Tyler Mordy, president and co-chief investment strategist of Toronto-based Hahn Investment Stewards.
When Q Magazine questioned R.E.M.’s lead singer about the lyrical density of his 1987 hit single, “It’s the End of the World as We Know It (And I Feel Fine),” Michael Stipe responded by saying, “The words come from everywhere. I’m extremely aware of everything around me, whether I am in a sleeping state, awake, dream-state or just in day to day life.”
Our investment committee’s cerebral activity—both of the conscious and unconscious variety—has also been more active of late. Of course, the subject is different (and does not have a hip drummer and bass player to back our musings).
The key questions at Hahn Investment Stewards are these: With the Federal Reserve’s third quantitative easing program (QE) set to expire next month, what are the implications for global ETF asset allocators? And, can we expect an encore or simply a return to monetary policy as we knew it before?
These are weighty questions. Since QE’s entrance onto the world stage, capital markets have soared on the Fed’s wings. To be sure, not all gains were government-sponsored. Some factors, unrelated to QE, helped drive economic recoveries and corporate profit booms.
But easy money, like champagne, removes inhibitions. QE—clearly a crowd-pleasing elixir—was no different, lowering the penalties for imprudence and uncorking a flood of speculative enthusiasm.
Preparing For The Post-QE Phase
Looking ahead, what are the key considerations?
First, a seamless transition away from QE is unlikely.
So-called policy normalization comes with risks. Recently, many point out that previous onsets of interest-rate-hiking cycles coincided with rising stock markets. This is accurate, but not relevant. The range of policy tools prior to those periods were mainly limited to manipulating overnight lending rates. Exiting from large-scale asset purchases is another matter altogether.
Crucially, the behavioral effects of QE should not be underestimated. Take corporate incentives as just one example. It is quite simple to identify a route by which QE-funded cash finds its way from the Fed into the hands of corporate executives.
What do they do with the cash? They purchase company equity, reducing the dilutive effect of stock options while simultaneously boosting earnings per share. It’s no surprise that U.S. corporations have actually been the major net buyer of U.S. equity in recent years, purchasing more than $500 billion in 2013 alone.
Now, imagine a world without QE facilitating the above transactions. Buybacks would be severely reduced—they are already down by more than 20 percent in the second quarter of 2014 versus the first quarter—undermining a key support for rising share prices.