Friday, July 26, 2013

QE and Equities: "Analysis: How much is Fed aid to U.S. corporate profits worth?"

From Reuters:
Many on Wall Street believe the Federal Reserve's monetary policy is behind record corporate earnings and the stock market's surge to all-time highs this year.

But how much is a burning issue for investors who wonder how the economy and stocks will perform once the Fed eventually eases its buying of $85 billion a month in bonds and eventually allows short-term rates to climb.

Some believe the influence of the Fed's policy, known as quantitative easing, has been particularly important to the performance of the benchmark Standard & Poor's 500 Index .SPX.

"People underestimate the extent to which quantitative easing has benefited the S&P," said Robbert van Batenburg, director of market strategy at brokerage Newedge USA LLC in New York. He called the effect akin to "an athlete on steroids."

The Fed's effect on corporate earnings is difficult to quantify. Van Batenburg estimates that corporate savings on interest expense after rates fell to historic lows has accounted for about 47 percent of S&P 500 earnings growth since 2009.

At the end of 2009, quarterly earnings per share for the S&P 500 were less than $20, and companies in the index paid about $4 a share in interest, van Batenburg said. Now the S&P 500 is generating about $26.70 a share in quarterly earnings but pays just $1.50 a share in interest.

Investors fear profitability could be hit hard when the program is reversed and rates eventually rise.
"Then the argument becomes, if interest rates normalize we're going to have to dial back that clock. Are we going to see a pullback in earnings?" van Batenburg said.

The mere suggestion that the Fed is preparing to reduce its bond-buying caused stocks to sell off. The market has since recovered even though U.S. bond-market rates remain higher than they were two months ago.

A look at rates suggests why earnings have more than tripled since 2000. The federal funds rate, the rate banks pay on overnight loans, was at 4.50 percent in late 2007. It was sharply reduced and now sits virtually at zero.

Long-term rates followed, falling from more than 5 percent in 2007 to record lows of about 1.4 percent in mid-2012. The 10-year U.S. Treasury yield was below 2 percent until late May.

David Rosenberg, chief economist and strategist at Gluskin Sheff + Associates (GS.TO) in Toronto, estimated in March that lower interest expense and corporate tax benefits have added about $30 a share to S&P 500 operating earnings....MORE
HT: MoneyBeat