A JT STRATFORD COMPANY
Of Money and Economics: The Effects of Quantitative Easing
A. Kip Pazol, Chief Equity Strategist
Dale Herndon, Executive Vice President
Central banks around the world are engaging in
“stimulus” programs to jump-start their
economies. One of the most popular programs
being implemented is Quantitative Easing,
or“QE” for short, a program whereby central
banks buy their country’s bonds in the open
marketplace resulting in enormous amounts of
cash being pumped into the market.
Money Printing – Has it Gotten a
Bad Rap?
Allow us to preface our opinions with this
unambiguous statement:
Excessive money creation that has become the
norm always ends badly for the economy as a
whole, especially for the lower classes that
these policies are intended to help.
The outlook below is very specific to the US
financial markets and for a finite period covering
the next 12 to 18 months, with the caveat that
revisions are to be expected as new data
becomes available.
But given the economic environment in the
European Union (EU), and much of the
developed world for that matter, they are
probably right to print money to stave off
deflation and jumpstart their economies, at least
in the short term.
In any case we see it as bullish for the US stock
market, given that the market has expected little
help from Europe, so any positive economic
growth would be an unexpected lift to corporate
earnings and stock returns.
So Who’s Printing Money?
It seems to be a world-wide phenomenon, with
the US sitting this one out since the Federal
Reserve (the FED) has already accumulated $4.5
trillion in assets through its three rounds of
easing that concluded in October 2014. The
European Central Bank (ECB) announced plans
to buy €1.1 trillion ($1.3 trillion) of government
bonds in January, Japan started their QE
program in the Fall of 2014 with the intention of
buying ¥80 trillion ($660 billion) worth of bonds
per year, and Sweden launched its quantitative
easing program in February 2015, announcing
government bond purchases of nearly $1.2
billion.
Additionally, other countries are either
considering or have already implemented other
stimulus measures, such as interest rate cuts.
Denmark, Turkey, and Peru, announced rate cuts
at the start of 2015. China, whose growth is
slowing but is experiencing little inflation,
lowered its interest rate by a quarter point, and
India, with a 5% inflation rate, surprised markets
in early March with its second rate cut in 2015.
What are the Short Term
Implications?
Obviously, any improvement in the growth
picture from the world’s economies will be
welcome, surprising and market moving, and,
ideally, that improvement would translate into
strong returns. In this case, however, we believe
returns will come from an expansion of market
multiples.
The reason we are of the above opinion is that
our slow-growing, underperforming economy is
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FIDUCIARY CAPITAL STRATFORD
increasingly looking like the safest place to
invest. With worldwide yields close to zero, high
quality US equities, with dividend yields above
2%, are still relatively abundant and becoming
increasingly attractive to foreign money, as
evidenced by the strengthening dollar. So on a
relative, and risk adjusted, basis the US stock
market is still an attractive investment. Add to
this the money held by pension funds and
individual investors who have yet to fully return
to investing in stocks post-2008, and we have
further monetary impetus to propel prices higher
over the near term.
We are forecasting a 7% to 12% return for the
S&P 500 for 2015. To achieve our midpoint
estimated return of 10%, the market multiple
would need to expand 8.2% (from 17 to 18.4
times earnings) to pair with its expected
operating earnings growth rate of 1% and its 2%
dividend yield.
Counting on an expansion of market multiples is
not the preferred way to expect increased returns
(increase in corporate profits is better), but given
the economic conditions described above, we
believe it is the route likely to happen. Further,
we are of the mindset that before the market
sentiment turns bearish, we could see multiples
exceed 20 times earnings.
Second, the hangover will be felt through a
misallocation of resources throughout the
developed world. After the UK implemented its
QE policy of £375 billion ($570 billion) in 2012,
the Bank of England reported that Quantitative
Easing had benefited households differently
according to the assets they held: wealthier
households accumulated more assets.
In the short term, however, financial assets will
continue to be the prime beneficiaries as the
equity and bond markets expand.
How Does This Affect our
Portfolios?
In our 2015 Market Outlook report, we
expressed cautious optimism for our equity
portfolios as we continue to identify quality
companies that are undervalued given our
conservative assumptions. However, we feel
more confident about the companies we invest in
relative to the average company in the S&P 500
due to our investments having lower valuations,
higher yields, higher growth or some
combination or the three.
We will begin to pare back equity exposure
when the either of the following occurs:

The most decisive factor for us is the
inability to find companies that meet our
criteria for quality and undervaluation
based on conservative assumptions.

When the overall market P/E multiple
on S&P operating earnings starts to
climb into the low 20’s.
What Happens With all This
Money in the Long-Run?
Quantitative Easing is like going to a party
where the drinks are freely flowing – everyone
is having a great time until they wake up the
next morning with massive hangovers.
This hangover is felt, first, through inflationary
pressures. Money creation is inflationary
according to all popular economic theories given
that an abundance of cash will cause prices to
increase. Some economies could benefit from
some inflation, such as Japan and the Eurozone
who are experiencing deflationary conditions;
however, the flip side is that inflation can
quickly spiral out of control and can hit
emerging markets particularly hard as a higher
percentage of the consumers’ budgets go to
basics like food and fuel.
Luckily, the stock market is trading at about 17
times earnings, and in combination with still
ultralow interest rates, we are able to find ample
opportunities for investment.
For the present, we believe the recent easing
efforts of Japan and the ECB, as well as the
stimulus programs implemented in other
countries, will provide much needed liquidity to
the markets, with the US stock market being the
main beneficiary. We will continue to monitor
the markets for any unwelcome aftershocks.
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