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Welcome back to Unhedged. It’s day three, and bulls and bears are already at war in my inbox. Thanks for the feedback. Email me if you want to join the fray: [email protected]
QE and stock prices (part one)
Jeff Gundlach, a very famous bond manager, said this recently:
“We’ve had a relationship between the Fed growing its balance sheet and the value of the S&P 500 that’s been in place for years now, ever since they started quantitative easing, and it’s almost like a law of physics. It’s like, if you take the capitalisation for the S&P 500, and you divide it by the Fed balance sheet, it looks a lot like a constant.”
Gundlach is smarter than I am. That is why he is rich and I am a journalist. And he is speaking metaphorically here. But when anyone suggests, even metaphorically, that the market follows laws like those of the hard sciences, we need to hit the big red scepticism button immediately.
Here is a chart of the S&P and the Fed balance sheet, from Refinitiv:
That relationship is not constant, even just since last year. The two lines move in the same direction, but at varying rates. The market went up very quickly with the first huge round of asset buying, but it has kept going up just about as fast, even as the Fed’s buying has slowed. This is an obvious point, but somebody’s got to make it, and today I am that person, apparently.
Here is a slightly longer-term look at the relationship:
The two lines don’t even have the manners keep moving the same direction! After the ’08 crisis, the Fed jammed its foot on the gas and the market kept falling, for a while. And between mid ’17 and mid ’19, the Fed tapered its holdings and the market proceeded higher, if unevenly.
At the same time, the relationship is clearly strong and important, right? Well, the chair of the Fed says it isn’t. Here’s Jay Powell at his last press conference, when asked whether the market froth was on his radar:
“There is froth in the market, and I won’t say it has nothing to do with monetary policy . . . but it has a tremendous amount to do with vaccination and the opening of the economy — that’s what has been moving markets.”
This is bullshit, in the technical sense of “bullshit” suggested by Harry Frankfurt. He’s not lying. The explicit factual content of his statement (“fiscal policy is not an important contributor to market froth”) doesn’t matter to him one way or the other. He is setting expectations about his own actions. The implicit message is: “Unemployment and inflation are all I care about; the market can puke fountains of green slime like Linda Blair in The Exorcist and I won’t do a thing.” Everyone knows that’s the message, and that he is not allowed make it explicit, and that is fine.
But we know Powell is understating things. Here’s John Hussman, a very famous bear, in the FT with a pithy and accurate description of how the QE-stock prices mechanism works:
“Central bank asset purchases operate by removing interest-bearing securities from private hands, and replacing them with zero-interest base money . . . amplifying the discomfort of investors who must, in aggregate, hold this zero-interest base money. The moment one attempts to place this liquidity ‘into’ the stock market, it immediately comes ‘out’ via the hands of a seller.”
QE means there is more money sloshing around. Sometimes, this makes people feel that they have too much of the stuff, relative to other things they can have, such as stocks. So they trade some money for stocks. But then someone else has the damn money, and they trade it away, too. It’s hot potato, but with cash. The increasing preference for stuff other than cash forces the price of that other stuff up.
This is a better explanation of the relationship between QE and stock prices than the common one that goes “by pushing Treasury prices down, QE lowers the discount rates on stocks’ future cash flows, increasing their price”. That explanation may be true, in a way, but this kind of mathy talk encourages the idea that stock prices are determined in a huge spreadsheet in the sky, filled with objective inputs. It’s physics envy again. Stock prices are not bound by the laws of matter, but by the uncertainties of psychology.
More on this tomorrow, unless some big news thing happens.
One good read: Buffett and Wells
This is my colleague Eric Platt’s news story on how Berkshire Hathaway has dumped most of its remaining Wells Fargo shares. The bank was once a Buffett favourite, before its 2016 fake accounts scandal and management’s cack-handed initial response to it. The Berkshire disclosure landed just before the Wall Street Journal declared that other investors “are pouring into bank stocks like never before” as a play on the recovery and rising inflation.
Wells Fargo is cheaper on a price/tangible book basis than Bank of America, the bank that Berkshire still owns a ton of. It is in the middle of a cost cutting program that should boost earnings in a few years. At some point it will get the regulators off its back so it can grow again. It looks like a classic Berkshire stock. Berkshire has a vast portfolio and makes these choices for all sort of reasons that don’t involve fundamentals. Still, I wonder what’s going on.