Uncovered: QE and stock prices

Welcome back to Unhedged. It’s the third day, and the oxen and bears are already at war in my inbox. Thanks for the comments. Email me if you want to join the battle: robert.armstrong@ft.com

QE and stock prices (first part)

Jeff Gundlach, a very famous bond manager, dit this recently:

“We’ve had a relationship between the Fed growing its balance sheet and the value of the S&P 500 that has been around for years, since they started to relax quantitatively, and it’s almost like a physics law. It’s like it takes the capitalization of the S&P 500 and divides it by the balance sheet of the Fed, it looks a lot like a constant ”.

Gundlach is smarter than me. That’s why he’s rich and I’m a journalist. And here he speaks metaphorically. But when someone suggests, even metaphorically, that the market follows laws like those of the hard sciences, we should immediately push the big red skepticism button.

Here’s a chart of S&P and the Fed’s balance sheet for Refinitiv:

This relationship is not constant, not even since last year. The two lines move in the same direction, but at varying speeds. The market rose very quickly with the first major round of asset buying, but has continued to rise almost as quickly, even when Fed buying has slowed. This is an obvious point, but someone has to do it, and today I am that person, apparently.

Here’s a look at the slightly longer relationship:

The two lines don’t even make the modes keep moving in the same direction. After the 08 crisis, the Fed ran out of gas and the market continued to fall for a while. And between mid-17 and mid-19, the Fed cut its holdings and the market advanced, albeit unevenly.

At the same time, the relationship is clearly strong and important, right? Well, the Fed chairman says he’s not. Here’s Jay Powell at his last press conference, when asked if the market foam was on his radar:

“There is foam in the market and I will not say that it has nothing to do with monetary policy. . . but it has a lot to do with vaccination and the opening up of the economy, that’s what the markets have been moving. “

That sucks, al technical sense of “shit” suggested by Harry Frankfurt. Don’t lie. The explicit factual content of his statement (“fiscal policy does not contribute significantly to the foam of the market”) does not matter to him in one way or another. He is setting expectations about his own actions. The implicit message is: “Unemployment and inflation are all that matters to me; the market can drag green silt springs like Linda Blair The Exorcist and I will do nothing ”. Everyone knows this is the message and is not allowed to make it explicit, and that’s okay.

But we know Powell underestimates things. Here is John Hussman, a very famous bear, in the FT with one graceful and precise description of the operation of the price mechanism of QE shares:

“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, as a whole, have to keep this money at a zero interest base. When it is tried to place this liquidity in the stock market, it immediately leaves through a seller ”.

QE means more money is saved. Sometimes this makes people feel like they have too many things, in relation to other things they may have, such as actions. So they exchange some money for shares. But then someone else has the damn money and they change it too. It’s a hot potato, but with cash. The growing preference for things that are not effective forces us to increase the price of these other things.

This is a better explanation of the relationship between QE and stock prices than the commune that says “by pushing Treasury prices, QE reduces the discount rates of future cash flows of shares, increasing their price.” . This explanation may be true, in some ways, but these kinds of material talks foster the idea that stock prices are determined in a huge spreadsheet in the sky, full of objective reports. He becomes jealous of physics again. Stock prices are not bound by the laws of matter, but by the uncertainties of psychology.

More on that tomorrow, unless some big news happens.

A good read: Buffett and Wells

This is my partner Eric Platt news about how Berkshire Hathaway has abandoned most of its remaining Wells Fargo shares. The bank was once Buffett’s favorite, ahead of his 2016 fake accounts scandal and management’s initial response. The Berkshire outreach landed just before the Wall Street Journal he declared that other investors “invest in banking stocks like never before” as a game of recovery and rising inflation.

Wells Fargo is cheaper in terms of price / tangible book than Bank of America, whose bank Berkshire still has a ton. It is in the midst of a cost reduction program that should increase profits in a few years. At some point, it will get regulators to pull back so that it can grow back. It looks like a classic Berkshire action. Berkshire has a broad portfolio and makes these decisions for all sorts of reasons that don’t involve fundamentals. Still, I wonder what’s going on.