WASHINGTON, DC: Without QE, will the stock market tank? Count me a skeptic.
QE refers to “quantitative easing,” the Federal Reserve’s multitrillion- dollar program of bond buying that is now ending. I recently devoted a column to whether QE worked as intended. The short answer is that we don’t know. The idea was that by buying bonds the Fed would inject money into the economy and strengthen the recovery. The added money would cause interest rates to fall and stock prices to rise. People would spend more.
My original column raised general questions as to how much this had happened. Let me now examine stocks in more detail.
If QE has artificially boosted stocks, we might have a bubble that, without added infusions of money, could burst. But did QE artificially boost stocks? Did it underwrite rampant speculation? Is the market dangerously overvalued?
For answers, I focused on one statistic — the price-earnings ratio (P/E). If a firm has stock price of $10 a share and its earnings (profits) are $1 a share, then its P/E is 10. My approach (hardly original) is to compare the market’s present average P/E with its historical P/E. If today’s P/E far exceeds the historical figure, then something is amiss. Either speculation is out of hand or some amazing development justifies wild optimism, with future earnings expected to soar. Usually, it’s the former.
What do the numbers say?
As of June 2014 (the latest complete data), the stock market’s P/E was about 19. That’s based on the Standard & Poor’s index of 500 stocks, as reported by S&P’s Howard Silverblatt. In contrast, the average P/E since 1935 has been about 17. To me, this suggests that stocks aren’t wildly overvalued. They’re trading within historical ranges. Indeed, they’re much lower than the average P/E since 1988, which was 24. This figure, of course, includes the period of the “tech bubble” in the late 1990s, when we know — with hindsight — that stocks were highly overvalued.
True, stocks have enjoyed fantastic gains since their lows in 2009 and 2010. But remember: These gains mainly recouped huge losses inflicted by the financial crisis. Compared to its tech-bubble peak in 2000, the S&P index is up only about a third — a modest increase over nearly 15 years. Moreover, the rise since 2009 and 2010 has an obvious cause: profits. For the S&P firms, they doubled between 2009 and 2013, according to Silverblatt’s figures.
What I conclude is that QE didn’t cause most of the market’s rise. Profits did. QE might have had some effect, but despite widespread claims to the contrary by Wall Street analysts and investment managers, the added impact was at most modest. If QE didn’t much boost the market, it couldn’t have created a “bubble.”
Note that nothing I’ve said precludes a decline in stock prices — even a steep decline or collapse. What today’s P/E tells you is that present stock prices are justified on the basis of profits that have already occurred. It doesn’t guarantee future profits and stock prices.
As everyone should know, stock prices reflect many influences: the state of the domestic and global economies; inflation and interest rates; business profits; geopolitical developments; technological shifts; government policies; the mood of investors. If any of these factors turns sharply negative, stocks could take a nasty tumble.
All I’m saying is that if there is a bubble, it almost certainly wasn’t caused by QE.
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