We do not dispute Newton’s Third Law: Every action has an equal and
opposite reaction. Every surge has a backwash. Booms are followed by busts.
And no rally lasts forever.
But financial markets do not conform to Newtonian theory. In physics,
principles and formulas are universal and, importantly, durable. Their
permanency doesn’t fade. Conversely, financial markets – much to the
chagrin of those still carrying the torch for the Efficient Market
Hypothesis – are driven by ephemeral opinions. Yes, they are arenas of
action and reaction. But they are also layered with dialectics of
suppositions, crowd-driven opinions, and, notably, flawed assumptions.
Unlike in physics, what’s right in one regime will be wrong in the next.
Therein lies the rub. A widespread misunderstanding of QE has defined the
post-crisis policy period. Most simply got it wrong, forecasting that the
monetary largesse created in response to 2008’s financial crisis would lead
to soaring inflation and crashing bond markets. The opposite actually
occurred. Bond yields shrank across the world (some going subterranean),
and deflationary forces loomed large.
In her final days as the Fed’s chairwoman, Janet Yellen even came close to
admitting that QE is still poorly understood by the Fed: “We believe we
understand pretty well what the effects are on the economy.” Translation:
What did the consensus miss? They misread the transmission dynamics of QE.
What is now clearly known (and forecast as early as 2009 by your favourite
Canadian macro managers) is that QE had more impact on the financial
economy than the real economy. The liquidity created was distributed to
capital owners (i.e., the wealthy) who have a far lower marginal propensity
to consume compared with the lower and middle classes. Thus, the injected
liquidity boosted asset prices rather than being multiplied by the credit
and banking systems. This at least partially explains the apparent paradox
of rampant asset price inflation with lower consumer price inflation.
Given the above, a useful exercise is to ask, if most market participants
missed QE, what could we miss now? This is the symmetry investors should
To start, we must acknowledge that QT is unprecedented. No one knows for
sure what may unfold. However, there are strong reasons to believe that the
Fed’s actions will have less impact than they have in the recent past.
Retrospectively, and perhaps as would be expected, QE had a bigger impact
the closer it was to the global financial crisis. A comprehensive study by
the Bank of England in 2016 found that QE had double the effect on economic
growth during the panic period of the financial crisis compared with later
Removing QE (when markets are functioning well) is very likely to have far
less impact than if markets were in turmoil. Today, the actions of central
banks have become predictable, even boring. Every major world central bank
is committed to a gradualist approach. Therefore, compared with the
fast-moving dynamics of QE during the financial crisis (when central
bankers were desperately trying to boost confidence in the entire financial
system), QT will be a glacial affair that plays out over several years. It
is not the equal and opposite of QE.
QT will have some impact on markets. However, it will not be the Armageddon
scenario currently being portrayed in much financial commentary. In the
months ahead, beware of luxuriating in the polemics of many well-known
bears. That was not a winning portfolio strategy since the crisis, and it
will not be one now.
Tyler Mordy, CFA, is President and CIO for
Forstrong Global Asset Management Inc., engaged in top-down strategy, investment policy, and securities
selection. He specializes in global investment strategy and ETF trends.
This article first appeared in Forstrong’s December 2017 issue of
Super Trends and Tactical Views. Used with permission. You can reach Tyler by phone at Forstrong
Global, toll-free 1-888-419-6715, or by email at
email@example.com. Follow Tyler on Twitter at
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