QE2 launched to much fanfare

This was no buy the rumor, sell the news week.  This week, it was buy the rumor, buy the news…whatever you do, just buy, buy, BUY!

The Federal Reserve will create dollars out of thin air and use them to buy debt issued by our Treasury Department, and this was good news to markets.  Everything, except the U.S. dollar, rallied. 

Happy days are here again.  A chicken in every pot, a car in every garage, prosperity for all.  Print away, dear Fed!

Okay, I’m just bitter because I thought  more than 3 people might see election outcomes, quantitative easing part 2, and 9.6% unemployment as less than good news.  I was wrong.

But, the little voice of reason in my head is screaming in protest, “How can printing money with no backing create prosperity?!  I know, for a fact, it can’t!!!” 

A lower dollar means a little extra business for a couple of U.S. exporters.  But, the U.S. imports vastly more than it exports, so it means higher costs for the majority of us. 

If you don’t believe me, look at commodity prices–they’re up 19% since August.  The rocketing price of cotton is jacking up clothing costs.  Oil at over $86 a barrel will translate into high gasoline and heating oil prices.  Copper closing in on $4 means higher prices for electronics.  Et cetera, et cetera, et cetera.

Soon, this will translate into higher costs and lower profits for U.S. companies.  It will also mean higher prices for all U.S. consumers.

Quantitative easing will not create jobs in the U.S. or increase lending to U.S. businesses (although both of those things are occurring completely separate from and despite federal action).  The Fed’s printed dollars are going to find their way into emerging markets, commodities and government bonds.  In the short run, it means “party on, Wayne”; in the long run, it means more inflation.

Oh, by the way, the last 2 times the Fed tried to create prosperity with the printing press (and the economy was not on the brink of financial collapse) ended in the dot-com crash and the housing crash. 

While the party is going, it will seem great, just like the NASDAQ and housing bubbles back in 1999 and 2006.  But, when it ends, and few will see it coming or be prepared, it’s going to hurt like no hangover we’ve ever experienced.

In the meantime, the markets will rally and the prudent will look foolish.  And, yes, I’m looking like a fool.

Nothing in this blog should be considered investment, financial, tax, or legal advice. The opinions, estimates and projections contained herein are subject to change without notice. Information throughout this blog has been obtained from sources believed to be accurate and reliable, but such accuracy cannot be guaranteed.

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QE2 launched to much fanfare

Expectations…fulfilled?

There’s a lot of news coming out next week, both mid-term elections and the Federal Reserve meeting to announce the much-anticipated launch of QE2 (quantitative easing, round 2). 

The key question for markets is: how much of the news is already factored into prices?

This points to one of the most difficult concepts for investors to grasp–prices do not reflect current or past information, but investor expectations.

Many investors are surprised when good news comes out–“company earnings grew 50%”–only to see a stock’s price tank.  Why?  Because market price already reflected greater than 50% growth. 

Or, they’re surprised to see bad news–“the economy shrank by 2%”–lead to a jump in the stock market.  Why?  Prices reflected a more than 2% economic decline. 

Prices, whether for bonds, stocks, commodities or currencies, reflect investor expectations.  Prices move up when actual news is better than expectations and down when it’s worse than expectations.

Which raises the question in my title: will news next week exceed, fulfill or disappoint expectations?  If fulfilled, prices won’t move much; if exceeded, prices will jump; if disappointing, prices are likely to fall.

Right now, investors clearly expect the Federal Reserve to announce a quantitative easing package that is favorable to bonds, stocks and commodities and bad for the dollar.  Will that announcement fulfill, exceed or disappoint?  Markets seem too optimistic to me, but as the old Wall Street saying goes: “don’t fight the Fed.”  On the other hand, is the Federal Reserve printing dollars really a cause for stocks and bonds to appreciate?  Something to think about.

Investors currently expect Republicans to take back the House of Representatives and make gains, if not restore a majority, in the Senate.  Do market prices already reflect that expectation, or will they be disappointed?  For that matter, are market participants correctly reflecting what will actually happen if their expectations are fulfilled?  Will Republicans cutting spending be good or bad for stock prices in the short run?  Something to ponder.

The S&P 500 is selling for around $1180 right now, reflecting an expectation of 14% per share earnings growth over the next year.  With the economy likely to grow at around 2% and profit margins at cyclical highs, is overly optimistic earnings growth expected?  What will happen to stock prices if those expectations go unfulfilled?

In the long run, investing success is all about paying the right price for an asset.  In the short run (which is what Wall Street does with less than 6 month holding periods), investing success is all about guessing investor expectations.  For those focused on the long run, next week is a non-issue.  For those focused on the short run, next week will be a nail-biter.

Nothing in this blog should be considered investment, financial, tax, or legal advice. The opinions, estimates and projections contained herein are subject to change without notice. Information throughout this blog has been obtained from sources believed to be accurate and reliable, but such accuracy cannot be guaranteed.

Expectations…fulfilled?

Buy the rumor, sell the news

An old saying on Wall Street is “buy the rumor, sell the news.”  It means that markets tend to react to rumors by bidding up prices and then selling (pushing prices back down) when the news actually hits.

Unless you’ve never read my blog before, you know that I don’t tend to pay much attention so this short-term, trader-oriented approach.  However, I am sometimes so completely baffled by the way markets react to news and rumors that I can’t help but remember the old saying.

Since late August, the stock market has rallied strongly, as have commodities and gold.  Over the same period, the dollar has tanked.  Since spring, the bond market has rallied strongly, too.  What’s going on?

In my opinion, bonds have rallied strongly because economic numbers have been weak.  Unemployment remains high, GDP growth has slowed, the ECRI weekly leading index has tanked (but is recovering), and new unemployment claims have stayed stubbornly over 450,000.  I think bond holders are forecasting a sustained slowdown or recession and continued deflation.  This should not be good news for stocks, commodities and gold, and should be good for the dollar.  So, why is the opposite happening?

In short, the answer is that Federal Reserve board members, since late August, have been strongly hinting that the economy is so weak it may need another round of “quantitative easing.”  For those of you blissfully ignorant of what the heck quantitative easing is, it’s economic jargon for central bankers printing money (without physical backing).  In this case, they will print dollars, creating money from nothing, and use those dollars to purchase government bonds on the open market.

Why is that good for every market except the dollar?  Good question.  It’s good for bonds, because the government will buy bonds in large amounts.  It’s good for stocks because this will supposedly goose the economy.  It’s good for commodities and gold but bad for the dollar because it means inflation.  If you’re confused now, good for you.

Let me summarize: the U.S. economy is doing so badly that the Federal Reserve is going to try to intentionally create inflation.  Somehow that’s good for stocks, bonds, commodities and gold, but not the dollar?  That can’t be so.  Inflation may be good for commodities and gold and bad for the dollar, but it’s definitely not good for stocks and bonds.  Something’s amiss.

Which brings me back to: buy the rumor, sell the news.  The Fed has not officially announced its second round (the first was in 2008) of quantitative easing (colorfully dubbed QE2 by market watchers).  That is most likely to occur in early November.

I think that markets are buying the rumor of QE2 and may very well sell the news come early November.  Markets may be particularly unhappy if the news of QE2 doesn’t meet its grand expectations. 

In the long run, bad economic news can’t be good for stocks and commodities.  If the Fed does manage to create inflation with QE2 (which is not a given), it won’t be good for bonds, stocks or the dollar. 

How can bad news about the economy be good news for markets?  In the long run, it can’t be.

My ability to time the market is somewhere around zero, so take what I have to say with a big grain of salt.  I’m not buying this rumor, nor selling the news, but caution is highly recommended.

Nothing in this blog should be considered investment, financial, tax, or legal advice. The opinions, estimates and projections contained herein are subject to change without notice. Information throughout this blog has been obtained from sources believed to be accurate and reliable, but such accuracy cannot be guaranteed.

Buy the rumor, sell the news