Investors should stay focused on positives when Fed ends QE3

Published in the Oct. 29 – Nov. 11, 2014 issue of Morgan Hill Life

By Dan Newquist

Dan Newquist

Dan Newquist

The Federal Reserve is expected to end its third round of quantitative easing (QE3) at the Federal Open Market Committee meeting in October. In a continued effort to stimulate the U.S. economy, the Fed began purchasing $85 billion worth of mortgage and treasury bonds per month in December 2012. The Fed has “tapered” (i.e., reduced in size) the amount of asset purchases over time on signs of a slowly improving economic recovery. With the end of QE3 imminent, an important question to ask is “How will the stock market react when the Fed ends QE3?”

A brief analysis of the previous two quantitative easing programs and the S&P 500 Index’s performance during and after those time periods may help us answer that question.

On Nov. 25, 2008 the Fed announced its first large scale asset purchase program, known as QE1. In aggregate, the Fed purchased $1.75 trillion of Treasury bonds, agency debt and mortgage-backed securities (MBS) from Dec. 16, 2008 to March 31st, 2010.

During this time period, the S&P 500 experienced strong gains, appreciating by 38.8 percent. In the first three months after the end of QE1, the S&P 500 declined by as much as -12.6 percent before recovering and posting a 2.9 percent gain for the period between the end of QE1 and the beginning of QE2.

In November 2010 the Fed communicated its intent to purchase approximately $600 billion in long-term Treasury securities under QE2.
The second round of quantitative easing began on Nov. 3, 2010 and ended on June 30, 2011, a period which saw the S&P 500 advance by 12.2 percent. In the six months after QE2 ended, the S&P 500 fell by -1.9 percent.

Under QE1 and QE2 stock prices advanced and benefited from the Fed’s aggressive economic stimulus policies. In the months after the end of both QE1 and QE2, the S&P 500 experienced market declines as investors responded to a change in Fed policy when unemployment was high and the economic recovery was struggling.

A little over a year ago, when the Fed first indicated that it would consider tapering its QE3 bond buying program, investors were thrown into a taper tantrum, sending bond yields up and stock prices down.

The taper tantrum was short lived, but in October, when QE3 ends, it would not surprise us to see additional stock market volatility as investors anticipate the Fed’s and economy’s next moves.

While the end of QE in the past has sent markets down, this time the economy is substantially stronger than during the end of prior QE programs. These factors are typically supportive of stock prices and should help investors stay focused on the positives in the economy and market.

DAN NEWQUIST, CFP®, AIF® is a Principal Investment Advisor Representative with RNP Advisory Services, Inc., a registered investment advisor, in Morgan Hill. He can be reached at 408-779-0699 or [email protected]. Securities offered through Foothill Securities, Inc., member FINRA/SIPC, an unaffiliated company.