Here’s an interesting note on quantitative easing and asset allocation from Andy Lees of UBS. He says:
The attached chart gives a simple overlay of the front month 10 year US Treasury future vs the front month S&P future. As you can see the S&P has now outperformed by 3% so far this year. Adjusting for the difference in yields (S&P has a yield of 1.94% and the 10 year yield is 2.54%), the S&P has outperformed by 240bpts. Whilst any QE seems almost certain to target Treasuries rather than equities, it is really there as an exit policy for the banks etc to switch into real assets, particularly given that the Fed has acknowledged that they have a inflation mandate.
With cash performing abysmally, Treasuries collapsing relative to commodities, and now starting to fall relative to equities, won’t asset allocators soon start to get worried that they are in the wrong asset at the peak of a bubble and rotate into real assets rather than the ones that the Fed is intent on inflating away. Buy the S&P Dec 1200 calls for 24
The Federal Reserve can supply the liquidity, but it cannot direct to where that liquidity is directed. This is why ultra-low rates in the wake of the tech crash created another bubble in housing and commercial property. It is also why monetary stimulus should not be the preferred form of stimulus; it is a blunt instrument and distorts the allocation of capital by infusing more credit dependent areas of the economy with cash and artificially propping up investments with longer-lead times and higher hurdle rates.
Artificially low interest rates act as a subsidy for those parts of the economy, creating a distortion which last decade led to an overbuilding of houses. Right now junk bonds are on a tear, with debt being issued at a record pace. The fact that high yielders are rushing to market should be considered prima facie evidence for the Fed’s pushing investors out further on the risk spectrum.