Quantitative Easing and Its Effect on the Stock Market
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Quantitative Easing and Expectations!

by Ian Harvey

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September 23, 2012

Introduction

Earlier this month, the Federal Reserve announced a third round of Quantitative Easing (QE). Stocks immediately jumped -- along with gold -- while bonds and the dollar fell.

What can we expect going forward?

By looking at the prior two rounds of quantitative-easing and seeing which sectors and assets benefitted (or suffered) from the Fed's actions, may help investors decisions now that QE3 is in the works.


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QE3

The Fed announced in 2012 that it would begin a new program of unlimited purchases of mortgage-backed securities –QE3 or quantitative easing three.

The first round of QE came during the financial crisis in 2008 and 2009. The second round (QE2), preceded by three months of fevered speculation, came in November 2010.

Unlike previous programs, the Fed’s third round of quantitative easing does not have a defined limit and will continue until the labor market improves, so long as inflation remains tame.

As part of the Fed's new scheme, a marked difference from the first two rounds of QE, it will buy $40 billion of mortgage debt per month.

Combined with its purchases of long-dated Treasuries under “Operation Twist”, this will see the Fed buying a total of $85bn of assets a month for the rest of 2012, similar to its QE2 program in 2010.

Operation Twist – the Fed’s program of switching its short-term assets into longer-dated Treasuries in a QE-like effort to drive down long-term interest rates – should be complete by the end of 2012.

Additionally, the Fed reiterated its stance of keeping interest rates at historic low levels, extending the time frame out until at least the middle of 2015.

QE1 and QE2

Below is a chart beginning in August 2008 and showing returns for stocks (Standard & Poor's 500 Index - SPX), gold (SPDR Gold Trust - GLD), the dollar (PowerShares DB US Dollar Index Bullish - UUP), and bonds (iShares Barclays 20+ Yr Treas.Bond (ETF) - TLT). This provides a feel for how these investments have done during the first couple of QE rounds. The shaded sections illustrate the periods from the announced date of QE1 through to the end of QE1. It is interesting to see how the assets did during times of QE compared to times in-between QE3.


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Bonds were interesting as measured by the iShares Barclays 20+ Year Treasury Bond Fund (NYSEARCA: TLT) as they spiked at the beginning of the first round of QE and then moved downward until it was over. Between the first and second QE periods, bonds moved significantly higher until right before the second round of QE -- at which point they struggled. Between rounds two and three, bonds posted huge gains. Perhaps the rally is over now that QE has started again?

Gold had been very strong throughout the first two rounds of QE and between rounds one and two. However, after QE2, you can see gold became quite volatile but still posted a decent gain between the two rounds. Gold spiked on the news of QE3. Gold bugs would love to see the latest round of quantitative easing bring back the orderly uptrend that occurred during rounds one and two.


Six Months Later From Inception of QE

This table might give you an idea on what to expect out of certain sectors over the next six months. It shows how certain ETFs representing different sectors fared in the six months after the announcement of QEs one and two.

The table is sorted by the average of the two columns. The coal sector -- as measured by the Market Vectors - Coal ETF (NYSEARCA: KOL) -- has been the best performer. It returned 86% in the six months after QE1 was announced and 19% after QE2. As you might expect, metals, materials, and gold have additionally done quite well. Retailing is another interesting sector near the top.

At the bottom of the list, we see the dollar and bonds. Both saw losses initially after the announcement of QE1 and QE2.


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Other Important Articles Relating to the Week Ahead

1. The Past Week Stock Market Results – September 24, 2012

2. The Week Ahead in the Stock Market – September 24, 2012

3. The Economy and Earnings in the Week Ahead – September 24, 2012

4. The Major ETFs in the Week Ahead – September 24, 2012

5. The VIX Ready to Move Higher! - September 26, 2012


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