Why Central Banks Aren’t Propping up Stocks

A few weeks ago, we pointed out that some central banks have started to taper their quantitative easing (QE) bond purchases without any ill effects, which shouldn’t be surprising since there weren’t any when they tapered over the past decade. But it seems the chorus of doom has only grown now that some Fed people have publicly alluded to taper talk being on the docket later this year. It could get louder, too, given the Fed’s announcement yesterday it will sell the (paltry) $14 billion worth of corporate bonds and corporate bond ETFs it amassed through its 2020 emergency facility by this year’s end. We think you can tune it all down. There is little reason to think tapering—or emergency credit programs ending—is bearish, as we will explain.

The main fear stems from the belief stocks’ recovery and subsequent new heights are due solely to central banks’ extraordinary policies. Supposedly, without the flood of liquidity the Fed (et al) unleashed, stocks would be struggling. As evidence of stocks’ artificial elevation, bull market critics point to allegedly sky-high valuations and outsized leverage. The implication: If central banks withdraw their monetary support, the house of cards will collapse. Hence, taper fears. Just talking about it is apparently cause for concern, breeding uncertainty and volatility, which attracts further attention—and dread.

While central banks’ financial lifelines may have helped calm the initial panic last March, don’t overrate them. (The Fed may even have precipitated some of that panic itself.) As we said then, beyond just being a lender of last resort, the Fed’s programs were a mixed bag. To the extent they allowed otherwise solvent institutions access to funds, we think they helped boost confidence. Verbally backing the corporate bond market—which they did more than through actual buying, as the tiny amounts in yesterday’s announced unwind shows—may have helped steady markets a bit. But it is a mistake to consider that monetary “stimulus.” (Similarly, emergency fiscal support has mostly replaced lost income.) Greasing the wheels to allow financial markets to function normally doesn’t automatically equate to overheating.

But also, supersized QE has done little to boost credit in the economy. The Fed has created enormous reserves, but banks have mostly sat on them. Bank lending isn’t exactly gushing, circulating through the economy and supercharging growth or inflation. Upticks in GDP growth and inflation look temporary, tied to reopening. Loan growth is slowing down, not ramping up. That could change—and is worth monitoring—but if excess reserves simply pile up, they generally don’t set the economy on fire.

Moreover, central banks are incapable of taming viruses or reopening the global economy, which is overwhelmingly what has shaped growth and growth expectations over the last year. That, in our view, is driving stocks. Not QE, but improving economic activity and earnings. For stocks though, that is old news at this point. Markets look ahead about 3 – 30 months, weighing the likely reality against the expectations they previously moved on. Stocks priced in the lockdown shock in February and March 2020. They have rallied since, looking forward and anticipating the recovery in advance—which we are now seeing.

It isn’t as if stocks are unaware of potential tapering over the next couple years. Rather, we think they are rightly signaling that it just doesn’t matter much. The last time tapering drew so much attention was May 2013, when then-Fed head Ben Bernanke touched on the subject in an address to Congress. Then too, people fretted the bull market’s demise. Everyone said the same stuff that they say now, and it wasn’t correct. While there was a slight pullback in the immediate wake of Bernanke’s suggestion, the S&P 500 rose 24% from the Congressional hearing and throughout actual tapering up to QE’s end in October 2014.^[i] It then continued beyond, adding another 87% amid rate hikes and the beginning of QE’s unwind.^[ii] Headlines warned about supposed monetary policy “tightening” all the while, until February 2020 when impending lockdowns clobbered markets.

This wasn’t a disconnect, but normal, rational forward-looking market behavior. Against prevailing sentiment for catastrophe to descend upon QE’s removal, the economy and earnings fared fine. There was no recession. Except for 2015, when Energy profits plummeted tied to oil prices’ collapse, S&P 500 earnings grew. The bull market didn’t end. For stocks to rise, they only need reality to exceed expectations—which is generally the case. The S&P 500 has risen in 68% of calendar years since 1925, suggesting markets’ bias is generally upward.^[iii] In other words, if you aren’t in a bear market, you are in a bull market—and that is highly unlikely to end for no reason. So, absent a good reason to be bearish, be bullish.

We think the bull market is in its later, more optimistic stages, picking up where it left off after last year’s lockdown-driven interruption. Usually, optimism continues heating up into broad euphoria with time—eventually blinding investors to lurking negatives. Folks fretting over taper threats suggests to us sentiment remains far short of that—there is still room for stocks to run.