Lacy Hunt at Hoisington Management emailed their 6-page fourth quarter report....
As always, the report is well worth a good look. One particular section caught my eye. It's on the failure of QE to produce the expected growth. Here are a few excerpts.
In a paper presented at the Fed's 2013 Jackson Hole Conference, Robert Hall of Stanford University and Chair of the National Bureau of Economic Research Cycle Dating Committee wrote "an expansion of reserves contracts the economy."
Causal Mechanism Explains Counter-Productiveness of QE and Forward Guidance
This empirical data [the Jackson Hole presentation] notwithstanding, a causal explanation of why QE and forward guidance should have had negative consequences was lacking.
This void has now been addressed by "Where Did the Growth Go?" by Michael Spence (2001 recipient of the Nobel Prize in economics) and Kevin M. Warsh (former Governor of the Federal Reserve), a chapter in a new book Growing Global: Lessons for the New Enterprise, published in November 2015 by The Center for Global Enterprise.
Their line of reasoning is that the adverse impact of monetary policy on economic growth resulted from the impact on business investment in plant and equipment.
In particular, they state: "We believe the novel, long-term use of extraordinary monetary policy systematically biases decision-makers toward financial assets and away from real assets."
Quantitative easing and zero interest rates shifted capital from the real domestic economy to financial assets at home and abroad due to four considerations:
First, financial assets can be short-lived, in the sense that share buybacks and other financial transactions can be curtailed easily and at any time. CEOs cannot be certain about the consequences of unwinding QE on the real economy. The resulting risk aversion translates to a preference for shorter-term commitments, such as financial assets.
Second, financial assets are more liquid. In a financial crisis, capital equipment and other real assets are extremely illiquid. Financial assets can be sold if survivability is at stake, and as is often said, "illiquidity can be fatal."
Third, QE "in effect if not by design" reduces volatility of financial markets but not the volatility of real asset prices. Like 2007, actual macro risk may be the highest when market measures of volatility are the lowest. "Thus financial assets tend to outperform real assets because market volatility is lower than real economic volatility."
Fourth, QE works by a "signaling effect" rather than by any actual policy operations. Event studies show QE is viewed positively, while the removal of QE is viewed negatively. Thus, market participants believe QE puts a floor under financial asset prices.WSJ, "The Fed Has Hurt Business Investment" by Michael Spense and Kevin Warsh.
According to a Spence and Warsh op-ed article in the Wall Street Journal (Oct. 26, 2015), "... only about half of the profit improvement in the current period is from business operation; the balance of earnings-per-share gains arose from record levels of share buybacks. So the quality of earnings is as deficient as its quantity."...MORE
And possibly the funniest headline I've seen this week: "In a follow-up Wall Street Journal opinion piece Michael Spense and Kevin Warsh take on Larry Summers in A Little Humility, Please, Mr. Summers"
Here's Hoisington's fourth quarter review and outlook.
