QE impact on equity prices

Updated: Mar 5, 2020

The Macroeconomic Context of 2019

According to a concept of technological paradigm, popular among the leading economists, the steady and crisis technological periods change each other through the mechanisms of depression, capital addition and the cardinal changes in the system of price changes in the economy. During those periods of 15 years length, there is a change in the price structure, sets of leading countries and industries, as well as the principles of economic metrics.

The periods of economic bubbles are getting replaced by the periods of steady economic growth with the pace of development. In economics, Kondratiev waves are hypothesized 45-60 years of generational cycles of invention seeds, expansion, and depression. Currently, we are at the beginning of the 6th wave of the post-informational technological revolution (Internet of things/renewable energy transition, nanotechnology) (2015–2035?). The innovation seeds of these new technologies have taken place in the previous cycle.

The periods of economic crisis are also the periods of outstanding opportunities for developing countries when they can jump on the growth path of the new technological order and get ahead in development. China is an example of such an economic miracle.

How are technological and global economy patterns manifesting themselves today?

Here is the illustration of the scale of the global derivatives bubble since the beginning of the the last great financial crisis struck in 2007-2008. According to OCC, U.S. Department of the Treasury, the top 25 banks in the United States in 2018 had a $206 Trillion of exposure to derivatives. The top 5 banks, including JPMorgan Chase Bank, Citibank NA, Goldman Sachs, Bank of America Na, Wells Fargo banks NA, are accounted for 93% of this amount. Derivatives value exceed its underlying asset value in 23 times. In the same time, the value of assets are not increasing with years.

What is behind of these numbers?

The major-country central banks have adopted a monetary policy, a quantitative easing (QE), whereby a central bank buys Treasury bond, government and mortgage bonds from the banking system in the U.S., corporate bonds and stocks in Japan, corporate debt in Europe. The aggregated money for those three- FED, BoJ and ECB -$15 Trillion in 2018. The Bank of International Settlements (BIS), or central bank of all central banks, repeatedly warns the danger of crisis 'relapse'.

How does QE impact equity prices?

This chart partly explains the rally of stocks and bonds. The studies conducted in 2014 demonstrates that the equity markets experienced as much as a 22 percent premium under the maturity extension program and QE3 versus the estimated returns had the Federal Reserve not implemented such programs. 

What is the correlation between price of the stock and company earnings?

By definition, the P/E ratio shows what the market is willing to pay today for a stock based on its past or future earnings. The graph demonstrate no correlation in the relationship between P/E ration and the S&P 500 (0.05 for the last 3 decades). The current high P/E ratios mean that investors are anticipating higher growth in price in the future due to the continuous rally.

How much do the countries spend on research and development?

According to UNESCOstat, Global spending by business, governments, universities on R&D reaches a record high of almost US$1.7 trillion. the U.S. is accounted for 28% of it (476B), China 371B, Japan 170 B, Germany 100B. About 10 countries account for 80% of spending. As part of the Sustainable Development Goals (SDGs), countries have pledged to substantially increase public and private R&D spending as well as the number of researchers by 2030.

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