While central banks can fuel meaningful short-term asset price rallies, sustaining the gains eventually requires evidence that extra liquidity is providing a lift to economic growth and profits.
S urvey evidence and equity sector relative performance suggest a high degree of skepticism among investors that QE will translate into economic growth.
Cyclical sectors led the stock market higher after the QE1, QE2 and “Operation Twist” announcements. In contrast, defensive sectors have outperformed since the latest QE announcement. Global growth appeared to be on the upswing around the time of QE1 and QE2. Today, the U.S. economy is approaching stall speed, Europe’s recession is deepening, and the near-term outlook for the rest of the world remains soggy.
Moreover, the S&P 500 index shot up 12% before the Fed’s latest policy announcement and is technically overbought. The forward P/E ratio has reached 13 times, significantly higher than when QE1 (12.3) and QE2 (12.6) were announced. Finally, the near-term outlook for corporate earnings is far less optimistic than it was during the previous two rounds of QE.
The bottom line is that we would expect another upleg in risk assets if the ECB and the PBoC were to join the Fed in providing another global liquidity injection. However, the clock is ticking because the fiscal cliff is approaching, and profits and economic growth indicators are not providing support.
For now, we remain constructive on pro-cyclical investments, though expect a consolidation phase ahead of the fiscal cliff.