Let’s take John’s car-chase metaphor a step further. So we’ve had this particular car chase going on since August. Has it endured so long because of the driver’s skills? Because he’s got some souped-up Olds 442? Or is it the gas in the tank?
It’s the gas.
This particular grade of fuel has been refined by the Fed. It is both the actual $600 billion the Fed’s spreading around via its QE2 bond-buying program, where the Fed has literally created $600 billion out of thin air and injected it into the economy, and the implicit “Bernanke Put.” The Fed has made it clear to all involved, without necessarily saying so to the unwashed masses, mind you, that it’ll stand behind the so-called risk trade. Stocks are the prime beneficiary, but so are commodities, for that matter. High yield’s been having a nice run, too.
The only concern for the market is whether or not there’s going to be a QE3, because these days, as Barry Ritholtz more or less said, it pays to follow the Fed. Not Egypt, not Europe, not politics, not unemployment, not even corporate profits for that matter. QE.
Make no mistake, a big, big part of the stock market recovery (as reader Chance pointed out) has been the Fed’s bond-buying programs, and the efforts to push investors out into the risk trade. It is no coincidence that the Fed started buying mortgage bonds at the height of the panic in November 2008 and announced its big, $1 trillion bond-buying program in March 2009, the same month stocks put in their recession lows. It was a rocket trip from there.
That program (QE1) ran out in March 2010, but the program had one feature that actually allowed it to sort-of run past its deadline: the time lag between when the Fed agreed to a specific purchase, and when it settled that account. That time lag was a period of several weeks. So while the program “officially” ended March 30, the payments kept running through April and into early May. A lot will depend upon how the Fed spreads out its purchases toward the program’s end.
The market put in a high in late April, and the sell-off began in earnest in May. It didn’t end until August, when Fed Chairman Bernanke first brought up the idea of QE2. The only time, since the lows of March 2009, that the market has appreciably sold off was when the Fed wasn’t actively buying bonds.
Now, we know the Fed doesn’t like to surprise markets. It often gives the market an advance warning when it’s going to change directions. So given that the current bond-buying program is scheduled to end in June, you can expect that the Fed will make it clear to the market by, probably, early May what it plans to do, whether extend the program again, QE3, or let it go.
We’re already seeing the debate within the Fed in the public realm. They’re letting us know that they’re already discussing it. We will know their plans some time in May. If the Fed does let the quantitative easing thing wind down, if it’s content to merely hold interest rates pinned to the floor at zero, you might expect a big sell-off. But the markets may not sell off immediately, depending upon the timing of the purchases.
So, as overbought as the market is, as over-exuberant, as overcrowded, it is quite possible that you won’t see an appreciable sell-off until July or even August. It sounds crazy to say it, to me at least. The markets are due, overdue, for a correction. But you can see the difference between when the Fed’s printing mone…I’m sorry, when the Fed’s quantitatively easing…and when it isn’t.
Is it possible that outside force, like the revolt in Egypt, could trip up this nice easy trade the Fed’s engineered? Yes, but Egypt is on the brink of a civil war right now and the market doesn’t seem very concerned. If you believe the markets are following the Fed, and there are very good reasons to do so, then it’s possible that this bull run may run for several more months.
Which just means you’ll have to endure several more months of Jim Paulson, Jim Cramer, Larry Kudlow and the rest of the CNBC fun-bunch crowing about how smart they all are, and how great everything looks.
(Photo: Library of Congress)