Quantitative easing (QE) is a government strategy of printing money in order to retire debt and purchase assets that increase the size of the public balance sheet. QE1, which occurred in March 2009, effectively took the markets off the mat. QE2 will likely also light a fire under stock prices, but the effect may be short-lived.
Since the assets purchased are all debt-related, there is little doubt that interest rates will stay low or even head slightly lower. Corporations will continue to sell bonds in this environment, which will increase their cash hordes even more. As more firms start distributing this cash in the form of dividends, investors will turn their eyes away from the negligible return of CDs and Treasury notes and toward the stock market.
The economy should respond to such stimulus, but not with the vigor of the public markets. If GDP growth doesn’t get a sufficient boost, investors will begin to focus on the falling dollar and rising government debt levels. Although I’m still expecting a rally, it may be in the form of a powerful spurt rather than a long-term trend.
Not everyone will win in the next upswing. The battered middle class, who is already cash strapped and struggling with high unemployment, won’t have the wherewithal to participate in the rally. This will serve to separate them from the upper class even more—a vexing long-term problem that we will eventually have to deal with.
Ben Warwick is CIO of Memphis-based Sovereign Wealth Management. He can be reached firstname.lastname@example.org.