This rally has been one of the most deceptive as it has been sparked, and supported by the so called, “Bernanke Put” and NOT by healthy macroeconomic conditions. The Bernanke Put refers to the notion that Federal Reserve intervention will save the stock market from downside risk by way of easy monetary policy. Despite the consistent negative economic data reports, and gloomy forecasts out of the US and global economies, stocks traded at a 10-12% premium on hopes of a third round of quantitative easing. Markets reacted positively to bad news, and negatively to good news, based on the logic that clearer signs of a weakening economy will push the Fed to act.
Markets finally got what they wanted last Thursday when the Fed announced a third and likely perpetual round of quantitative easing in which it will buy $40 billion of mortgage-backed securities each month. The Fed hopes to revitalize our sluggish economy by bring down mortgage rates to create housing wealth in hopes of increasing consumer spending to ultimately aid the suffering labor markets. It is important to note that the first two rounds of QE were not very effective. The stock market is up 2% from the announcement and is trending higher, but what has changed fundamentally? Nothing. The only reason for QE3 is a weak economic consisting of anemic GDP growth of 1.7%, unemployment above 8% for the last 43 months, and weak consumer spending. I see nothing to celebrate.
I believe this is a fool’s rally, and the opportunity is to the downside. Stocks will most likely continue to rise throughout the election before making a hard reversal. “The bull goes up the stairs, the bear jumps out the window.” I would look to take some profits off the table before he jumps.
History proves the only thing certain with easy monetary policy is inflation. While the annual rate of inflation from 1985 – 2011 has been tame at 2.1%, an open-ended quantitative easing policy certainly increases inflation fears. With inflation risk on the table, accompanied by the fiscal cliff and the ongoing European debt-crisis, investors and policymakers have little to celebrate. The end result will not be pretty.
Ciro J. Lama is currently an undergraduate studying Finance at the Zicklin School of Business – Baruch College
Website: CantalinoAssetManagement.com
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