June 11, 2012

Da Bulls and Da Bears: The See-Saw Market and Prospects for QEIII

If you're from Chicago, the first part of this headline probably conjures up images of two pretty good sports teams. However, for the rest of the country, it represents the ups and downs of the stock market over the past 12 years. Last week the bulls reigned, while a week earlier, the bears had bragging rights. For advisors who used the 1980s or 90s as a reference point, the past decade has provided a whole new learning experience. This see-saw market has many people seeking answers. 

It's rather obvious that Europe didn't solve its problems overnight, but last week saw the markets have one of their best weeks in a long time. What was the catalyst? What propelled stocks? More buyers than sellers? Was it the testimony of Fed Chair Ben Bernanke? Although he didn't actually say anything about QEIII, his silence seems to have been taken as a positive sign. This reminds me of how some used to read former Fed Chairman Alan Greenspan by the way he carried his briefcase. We are, you see, creatures in need of answers. And when there is no absolute answer, we sometimes opt to invent one.

Let's take a closer look at QEIII, or should I say, the markets’ most likely reaction to quantitative easing. Japan, which has had over 20 years of fighting deflation, has used quantitative easing on several occasions. Each time, stocks rose. Then when QE was finished, stocks fell. The same thing has already occurred here. 

What is QE and what exactly does it do? QE is the printing of money. It expands the money supply, devalues our currency and causes inflation, commodities and stocks to rise. In theory, it puts more money into the system, thereby causing it (the money) to be cheaper (lower interest rates). All this is intended to cause an increase in borrowing and a boost to the economy. 

However, as I discussed in a past article for Investment Advisor, due to low consumer demand and tighter lending standards, much of this "excess" money remains in the Federal Reserve banks. The Fed's balance sheet, which has risen from a pre-crisis $800 billion to well over $3 trillion at present, has not made it into the general economy. Again, there's not much more the Fed can do. That's why Bernanke has stated on more than one occasion that Congress must address its fiscal policy. Translation: Get your spending in line! Another round of QE will only cause a temporary spike in prices, but will not solve the problem. If you begin to hear talk about the risk of deflation, then look for QEIII. In the meantime, last week's rise could have something to do with the upcoming election. 

This period in history is remarkably similar to the end of the 1970s. I wonder if Eureka College has another good candidate for us today? After all, Reagan's supply-side, low-tax policies worked out pretty well, didn't they?

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