How Long Can These Markets Run on QE ?

Alternate title: Cross Current Between Economic Data & QE


Today marks the end of the month and quarter. Hence, it is a good time to look over the key economic and market data, and try to assess where we are in the overall cycle.

The data itself suggests several contradictory factors are driving markets. Durable goods orders — those big ticket items like autos, washers, and machinery — have plummeted, suggesting a rapid slow down in the economy may already be occurring. The most recent GDP revision at 1.3% seems to confirm this. Overall income gains have been mediocre. Unemployment remains stubbornly high, with people out of work for an extended time period also at record levels. ECRI, which has one of the best track record in forecasting recessions, is sticking with their 2012 recession call. (See this and this)

This mediocre recovery is, as Reinhart & Rogoff forecast way back in February 2008, exactly as we should expect. This is what the typical post-credit crisis recoveries look like — barely above stall speed.

At the same time, Housing has remained surprisingly robust. While metrics like Existing and New Home Sales volume and prices are still far below the 2006 peak, they have moved significantly off of their lows.

All the while, the market continues to grind higher, disbelieved by a significant percentage of market participants. For the month of September, the S&P500 looks to be up 2.69%; for Q3, the gains were 5.98%. YTD the markets are up 13.32%.

How can we reconcile these apparent contradictions?

In a word, it is the Fed.

My read is the only thing standing between you and an ordinary cyclical recession — including a 20-30% drop in the SPX — is monetary policy. The impact of QE and the FOMC mortgage backed purchases has kept the economy from a full blown recession — but only just barely. Indeed, the data we have seen this week strongly suggests that but for the juiced Housing market — artificially propped up by unprecedented low interest rates — the US would already be in a recession.

Typically, we see some sort of Fiscal stimulus in environments such as this. A misguided and AWOL Congress has managed to avoid doing that for suspect reasons. Whether its a flawed belief that austerity will be our savior or the partisan adherence to Party first, Congress is not acting the way they typically due following major recessions. The public seems to recognize this, and gives Congress its lowest approval ratings in history.

For the investor, ALL IN or ALL OUT makes little sense. Instead, they should be paying closer attention to the the signs as to which of these forces is winning the battle. This quarter, the Fed has trumped economic concerns. But with each subsequent QE generating less and less bang for the buck, a fair question to ask is “Just how long that can continue for?”.

History suggests that markets — artificially jacked up or not — tend to run for much longer than most people expect. That has already been the case since the March 2009 lows, now up over 100% in three and half years.

The danger is that “longer than expected” does not mean forever.

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