Quantitative Easing 2012-2013

The markets can be simplified down to a few different variables over the past few years.  QE also known as quantitative easing = risk on, no QE = risk off. It is that simple. Currently we are about half way through the tapering process, or elimination of QE.  At the peak of QE the Federal Reserve was providing $85 billion per month.  At present that amount has been tapered down to $45 billion.  How will the markets react in the absence of QE?  Let's go back a few years to see what kind of corrections were exhibited at different phases of QE.  Below is a 2012 chart of the S&P 500 at the time when QE was running $45 billion per month.

There happened to be two corrections, one was -10.6%, and the other was -9.1% during the year of 2012 while there was $45 billion each and every month available to aid the economy. The chart below fast forwards to 2013 to see what transpired with QE at $85 billion per month (almost double from 2012) granted from the Federal Reserve to aid the economy.

The corrections/pullbacks were small in percentage and duration with the average pullback around -4.9% and the steepest being -7.3%.  In 2013 it was risk-on, which meant every dip was bought that led to new highs in the market, and the high beta sectors benefited from the excess $85 bllion per month liquidity compared to 2012's $45 billion per month.

Bottom Line:  If added liquidity in the form of quantitative easing was the fuel for the markets in 2013, the lack of additional liquidity in 2014 due to the tapering off of approximately $10 billion per month may have the reverse effect.  Due to the lack of stimulus, steeper and longer duration corrections similar to 2012  (-10.6% and -9.3%) could be the new norm in the future. Thank you for reading.