Since our last post, one might think that based on stock prices alone, all is right with the world. That is certainly the intention of those in charge. After hitting the lows in mid-October, we have witnessed a historically significant (based on speed) greater than 10% bounce in commonly followed indices. History would suggest to us that such a move at this point in the cycle is not necessarily a good thing for stocks going forward, but belief systems like the current one have also shown themselves to be more durable than logic and math would dictate.
Ultimately, the Fed announced it was ending QE3 near the end of last month because the economy is now strong enough to withstand the cessation of the program according to the script. However, recent market drama is likely a sign that the post U.S. QE road ahead may be much tougher to navigate. The economic data certainly is no more robust than it has been for the last few years. Though equities may still see central bankers as miracle workers, other markets are not giving an “all clear” signal. In particular, the collapse in oil prices is a harbinger of slower growth to come in the important energy sector. Most significantly, Japan’s latest round of yen printing cannot be overestimated in its impact in the currency debasement wars and global trade.
When stocks were at their lows, more QE was suggested as an antidote by one alarmed and mercurial voice from within the Fed, that of James Bullard. That ignited the rally. In addition, to create the robust environment illusion of surging stocks, various central bankers and deciders from Europe, China, and Japan also had to promise that more money printing or other government initiatives were on the way. Japan actually followed through on Halloween with a more “mammother” QE program. Their last one did not help the real economy in the ways the Bank of Japan had hoped and promised, so in its twisted logic it decided to go to an extreme that seems like pure panic to us and to many other observers. It will be buying just about all of the debt issued by the Japanese government because it sees no other way to escape the debt deflation spiral. Even though we had expected a “no holds barred” approach there, all we can say is…“wow!” We have found out in recent days that Japan is officially back in recession, so one really has to wonder how long the QE belief system can be sustained. The experience there is proof positive that QE is no elixir for a poorly functioning economy and it cannot improve corporate earnings in any predictable or sustainable way.
In Europe, the ECB is doing everything in its power to unleash a QE program of enormous size, but it simply cannot agree on an avenue for such a scheme. It floated the idea of buying corporate bonds in the open market (when stocks were swooning, of course) but the Germans did not like the concept one bit. Besides, the Euro corporate bond market is just not big enough to accommodate the sort of wanton recklessness favored by ECB head, Mario Draghi. It greatly concerns us that some European bank stocks cannot get out of their own way after the mixed results from the stress tests there. Also, Greek bond prices are becoming volatile again. We are getting a clear message of problems becoming more acute. The EU economy has turned for the worse and the stock charts suggest that more credit drama lies ahead.
In the U.S., one major concern is the fact that while many companies are beating EPS estimates, they are doing so by a smaller amount and revenue growth is becoming increasingly sluggish. Many multi-national companies received a poor response to earning reports because sales volumes softened and the stronger dollar served to compress earnings even before Japan’s latest salvo. That dollar strength is cause for revisions to EPS estimates and one has to wonder how long U.S. and Chinese deciders will allow the deflationary effect of this to continue. Ending QE3 in a vacuum is one thing. Ending QE3 when the Bank of Japan is unleashing a tidal wave of deflation is another. At some point, markets will realize that all currencies are suspect in this race to the bottom. Gold and silver may, at that point, be perceived as being in short supply.
As time passes it becomes increasingly clear that QE has been mostly a failure for the real economy, but the powers that be have wedded themselves to the belief that it works. Japan’s new extreme QE initiative will not be the last effort of the central bankers because cheapening fiat currencies is the end game since it makes outstanding government debts less onerous.
The views expressed on this blog are the opinions of the authors. This information is not intended as investment advice or to recommend the purchase or sale of securities. More information on Strategic Balance, LLC may be obtained by contacting investor relations.