Are equities propped by stimulus versus an improved economy?

”Investors have been speeding along to record highs with a significant boost from the trillion-dollar-a-year turbocharger from the Federal Reserve. But the potential for Fed Chairman Ben Bernanke to lift his foot off the gas to use his metaphor has been sending markets into reverse.

Last week, U.S. stocks suffered their worst week of 2013, with the Dow Jones Industrial Average shedding 344 points or 2.2% by Friday, after posting its eighth down session of the past 10. And that, in large part, reflected the surge in bond yields on the prospect of the T word taper or the reduction in the Fed’s $85 billion-a-month purchases of Treasury and agency mortgage-backed securities. The benchmark 10-year Treasury’s yield wound up at a two-year closing high of 2.83%, up a hefty 25 basis points (one-quarter of a percentage point) on the week.

That the equity market shudders on the prospect of a taper beginning possibly as soon as the Sept. 17-18 meeting of the policy-setting Federal Open Market Committee isn’t surprising. Wilshire Associates reckons that a cool $2.9 trillion has been added to the value of U.S. stocks since the third round of quantitative easing better known as QE3 was announced last September. But the efficacy of quantitative easing in achieving its stated goal of spurring the economy as opposed to asset prices has been, at best, modest.

According to an article in the FRBSF Economic Letter by researchers Vasco Curdia of the San Francisco Fed and Andrea Ferrero of the New York Fed, the previous round of Fed purchases QE2, which totaled $600 billion added an estimated 0.13 of a percentage point to real growth in gross domestic product and 0.03 of a percentage point to inflation. Moreover, even this negligible boost fades after two years, they add.

Writing in the Washington Post in November 2010 to explain the Fed’s decision to engage in QE2, Bernanke asserted that the Treasury purchases would help push up stock prices, increasing consumer wealth and confidence, and thus encouraging spending. The San Francisco Fed article suggests that, while the stock market hovers near historic highs with QE3 still in full swing, the effect on the real economy is rather less pronounced and transitory.

Wall Street is showing itself loath to give up QE3, even gradually. Investors have found that Fed buying has produced rising prices of assets almost across the board, especially in stocks and real estate.”