Submitted by Peter Tchir of TF Market Advisors… 

Submitted by Peter Tchir of TF Market Advisors

QE3, what’s not to like?

Even the most die-hard bear or those who simply believe QE2 did more harm than good, have to resign themselves to the fact that this Fed will enact QE3 at its earliest possible convenience.  While I remain convinced that some current 5th grader will eventually be awarded a PhD in economics (not from Princeton) for their work on the folly of the QE programs, it is time to prepare for QE3.  Those of us who had hoped the dissent from the August FOMC meeting was a sign that the Fed was wavering on its “print and print some more” philosophy, have seen those hopes dashed against the rocks.  The doves have come out in full force.  The minutes show that some members think we should have already started QE3 and now one of the dissenters has backtracked.

I think that playing this from the perspective of being long stocks is a potential mistake this time around.  “Daily Needs” commodities should do well and even the stocks of companies that produce them.  PM’s should do well, since whether they will work long term or not, they have rewarded those who have treated them as de facto money for the past couple of years.  High Yield bonds had seemed oversold, but that trade already appears to have reversed too far, too quickly as investors have piled back into risky assets.

Will QE3 Support Stocks?  

It is virtually impossible to find anyone who doesn’t think QE is bullish for stocks.  It is easier to find someone who still believes Obama deserves a Nobel Peace prize than it is to find someone who thinks stocks won’t do well because of QE3.  That is scary.  Whenever the market becomes universally convinced of something, it gets set up for disappointment.  Not the disappointment that QE3 won’t come (it is coming), but that everyone has fully priced it in.  It is hard to remember anything from a year ago, but even when QE2 was announced, there was some question of how much good it would do for stocks.  There was actual debate.  There was the famous Tepper moment on CNBC where he dispelled the debate and stocks started a relentless march higher.  Until that point, and even to some extent, after that, investors debated whether or not QE2 was really good for stocks or not.  By the end, the only investors who were arguing that QE2 had little impact on stock prices, were the bulls and they were only saying that as a justification why stocks would remain strong after QE2 finished.

What did stocks really do during QE2?  

What actually happened to stocks under QE2?  It was first hinted at in Jackson Hole in late August with the S&P 500 at 1050.  By the time it became official policy on November 3rd, the S&P was already up to nearly 1200.  Stocks actually closed the month of November lower than where they were on the day QE2 was made official.  From that point, there was a relentless march higher, peaking at 1340 in February. Then market bounced around in a fairly wide trading range.  Peaking just north of 1350 a couple of times, but trading back down to 1265 a few times as well.  Stocks finished June 30th, the end of QE2 at 1320.  Since the end of QE2, it has been as low as 1100, almost back to where stocks were when the whole program was first hinted at.  The half life of QE seems to be shorter than that of a teenager’s viral video fame.

So, if nothing else had gone on in the world, and all of the moves in stocks were attributable to QE2, how should it be viewed?  It seems as though the bulk of the benefit came prior to its official announcement.  Stocks were up 150 points since Jackson Hole.  SPX only gained 120 points from then until it concluded on June 30th, and except for a 2 month period where it was a daily grind higher, the market was volatile and had several -5% moves.  The hype surrounding the potential for QE3 seems to be greater than the actual performance.

What else happened in that time frame?  Well, at the end of August, the EFSF was officially unveiled.  It was almost comical in its construction, but the market liked it.  The ECB added Irish and Portuguese debt to its bloated balance sheet already loaded down with Greek debt.  Ireland received IMF support.  We had an election that was viewed positively by the market.  Remember all the “hope” surrounding those November mid-term elections?  Then Obama allowed the Bush tax cuts to remain in place and added some payroll tax cuts just to keep everyone happy.

So maybe, just possibly, some of those events also played a role in the performance of the stock market? 

What is different this time?

So before going “all-in” long based on QE3, it is worth spending some time to figure out what is different this time around.

Now everyone believes QE3 will ensure stocks go up, there was doubt about that in the past.

Stocks jumped 150 points from the first hints in 2010, until it was actually implemented (we are up 125 from the lows already).

Stocks were at 1050, rather than 1225.

The ECB was worried about inflation and was willing to raise rates and not fight the dollar devaluation with their own debasement program.  With the slew of weak data coming out of Europe, it might be prudent to assume that they are working on their own devaluation plans – which may not help US stocks.  Although the S&P is up almost 13% in the past 12 months, it is only up 1% in Euro terms.  Making the assumption that Europe will play nice again is a risky proposition.

Investors, politicians, and maybe even some real people actually believed in the wealth effect.  It should be clear now that the wealth effect is enjoyed by a limited number of households.  Their purchases can drive the earnings of Tiffany’s and Saks, but the move in stock prices didn’t really help the average family.  How dumb does the Fed think the average American is?  The Fed and Wall Street say your pathetically small 401k (average of 75k according to Fidelity) is up, so spend, spend, spend!  Yes, spend, and please ignore all the talk about taking away those pesky little “entitlements” that you feel entitled to.  The wealth effect is too small, especially when everyone realizes pensions and benefits that they had planned on are being stripped away, and that housing isn’t coming back any time soon, and that earning interest on balances is a thing of the past.  Their 401k isn’t even “waking up and getting out of bed” money to most of the people advising them to spend.  That is bizarre and seems unstable.

Transitory used to be a word that meant something that came and went.  It was a temporary thing.  Now it only means something that the Fed wants to pretend they aren’t responsible for.  The CRB index was 268 last September 1.  Today it is 342.  Yes, it was above 360 at one point, but that doesn’t meet any normal definition of “transitory”.  The Fed has unleashed inflation pressures, and even if we don’t admit it, the rest of the world understands it, and will take policy measures to protect themselves.  We do not make policy in a vacuum.  Other countries see what we are doing and do react.  The reactions may not be instantaneous but they are real and will have long term impacts that are difficult to change.  Pretending the pursuit of QE doesn’t cause other nations to take steps, potentially to our detriment, is short sighted and wrong.

Contagion in Europe was whether Ireland and Portugal could be contained.  It is now about Italy and Spain and the banks in all countries.

That Europe was in a “liquidity” crisis rather than a “solvency” crisis was believed by many.

The US was AAA at all rating agencies and had not made a fiasco of its debt ceiling and spending.

BAC didn’t “need” money and was trying to increase its dividend when its stock price was $13.50.  Now they still don’t “need” the money, but are happy to dilute shares with sweetheart deals at $7.

I can write an entire article about QE and not mention the effect on the treasury market, and not feel like I’m missing the key market impacted by QE.

Entrepreneurs are nervous about the uncertainty.  Not the uncertainty the establishment constantly points out about taxes and debt ceilings, but the uncertainty that comes from policy after policy that benefits the incumbents at the expense of those looking to profit from being prepared for times like this.

Maybe all the Fed members can read Winnie the Pooh and the Money Pot prior to the September meeting.  It is a simple story of how greed, and gluttony, and doing what feels good now, can have some very negative long term consequences.  That story ends well, but maybe the path of printing money won’t.  Another round of QE3 may not do much to help the stock market this time since so many of the factors are different, so much has been priced in, and there were many other positives that helped stocks last year that may not reappear.