My best reckoning in January was that 2011 would be a catch-up year and that U.S. equities should perform well. This proved to be the case in the first quarter. But, investors need to analyze what’s happening and challenge their expectations every quarter. Even though things seem to be working just fine, we must constantly reassess and ask, like former New York Mayor Koch, “How am I doing?”

So, how are we doing? Has anything changed over the past quarter? Yes, actually the “overweight everything” investment process is officially over. That easy trade to overweight all risky assets ran its course. Look at the first-quarter performance of the S&P 500 and you’ll see in late February when the market started to slip, well before the sell-off that followed Japan’s earthquake on March 11.

The winding down of QE2 is behind this shift. QE2 brought stability to the markets and made it possible for investors to overweight everything. When Fed Chairman Ben Bernanke began talking about a second round of quantitative easing measures last September, he essentially gave investors a free “floor” underneath the stock market. Promising to buy $600 billion in Treasuries was his way of reassuring investors not to worry about the negative economic data we saw last August or the possibility of a double-dip recession. He made sure the bond market would not riot and encouraged investors to trade their safe-haven fixed income assets for riskier assets.

Our central bank’s campaign of buying Treasuries to hold down interest rates will expire in June. But to stave off any synchronized rush for the exits, and to ease any withdrawal in the aftermath, count on Ben to drag out the end of “QE2” over at least three acts.

Act One could come as early as Wednesday, when Bernanke will end a policy meeting with an unprecedented press conference and get coy with reporters. To smooth the transition, he’s expected to detail plans to reinvest maturing securities and interest back into the Treasury and mortgage markets, which will help keep the Fed’s balance sheet big and indulgent for a while longer.

Next, if the economy continues to thrive after it’s taken off life support, the Fed might begin to let maturing securities roll off its books. “This passive contraction in the Fed’s balance sheet will likely be a prelude to explicit tightening,” notes one well known economist and chief market strategist. Only then will the Fed begin to unload securities or raise short-term interest rates—a final act that could be more than a year away. Source, in part, Barrons and Reuters.