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A Market in Fed-Anticipation Mode

September 12, 2012
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We are just one day away from the Federal Reserve’s decision on what just about everyone on Wall Street is hoping for, and that’s another round of quantitative easing, or QE3. The majority opinion out there among economists is that the Fed will institute some form of monetary stimulus, although there’s hardly any consensus on what form that stimulus will take. Moreover, there’s not much of a read on how big a potential QE3 might be. Until we get the word directly from the Federal Open Market Committee’s (FOMC) statement, which will be midway through Thursday’s trading session; the market will remain in anticipation mode.

 
Now, I am of the opinion that another round of QE is akin to pumping up the equity and commodity markets with fiscal steroids. Yes, it is likely to inflate stocks and commodities for a while, but that bloating is ultimately destined to deflate, and when it does, it’s going to be very painful. That pain could be all the more intense given the fact that stocks have been bid up in anticipation of QE3.
 
The chart below of the S&P 500 Index over the past two years tells the tale of a liquidity-driven market that’s moved to multi-year highs thanks largely to the Fed’s actions.
 
 
 
The general rise in domestic equity prices has been impressive, especially because it’s occurred in the face of major headwinds such as a rapidly slowing Chinese economy, a major recession and fiscal crisis in Europe, and an anemic growth and jobs picture in the United States.
 
Of course, the domestic market has been an area that’s done much better than other equity markets around the world. In China and Japan, the second- and third-largest economies in the world, respectively, we are essentially still in a bear market. Major market averages in both countries fell more than 20% from their recent highs. Though they have come off of their lows, both are still well below where they were in 2011, as the charts here of the iShares FTSE China 25 Index (FXI) and the iShares Japan (EWJ) clearly show.
 
 
In Europe, stocks had a really tough time of it from May 2011 through June 2012. Despite a surge higher on hopes of a European Central Bank (ECB) bailout, stocks in the iShares Europe 350 (IEV) also remain depressed and well off of their 2011 highs.
 
 
 
The recent gains in the United States and Europe, and to a smaller extent in China and Japan, reflect the notion that central bankers around the world can solve our fiscal problems. This view is egregiously misguided, in my opinion, as the fundamentals of the global economy aren’t significantly altered by adding more cheap dollars into the mix. In fact, the long-term consequences of more money floating around actually may have negative implications for the global economy in the long run.
 
Of course, Wall Street isn’t a long-term proposition these days, and hence we’ve seen traders bidding up stocks in front of the Fed. How long will this last? Well, nobody can say for certain, but my suspicion is that things are going to end badly for stocks, especially when investors realize that the jig is up, and that the emperor has only a suit of cheap fiat currency to hide behind.