Good News — I Was Wrong About QE2

Well, I’m happy to say that I was dead wrong about QE2. I said its size would be small. It’s not. I said that it would disappoint Wall Street and that stocks would fall this week. They haven’t.

My inaccurate forecast has been great for our Buy List. As of now, our Buy List is up over 1.7% today, which is 40 basis points more than the S&P 500.

The S&P 500 is currently at 1,214. We’re inches away from the Magna Carta. At this rate, we should be at the Bubonic Plague in no time.

As Bernanke wrote in his editorial, QE is a “less familiar” tool of monetary policy so we don’t know exactly how to respond. Normally, lower interest rates are good for stocks. With QE2, the Fed is depressing the mid-range of the yield curve (note the distribution in the New York Fed’s statement).

The following paragraph is getting a lot of attention. Many folks see this as Bernanke saying he’s going to push for higher stock prices.

This approach eased financial conditions in the past and, so far, looks to be effective again. Stock prices rose and long-term interest rates fell when investors began to anticipate the most recent action. Easier financial conditions will promote economic growth. For example, lower mortgage rates will make housing more affordable and allow more homeowners to refinance. Lower corporate bond rates will encourage investment. And higher stock prices will boost consumer wealth and help increase confidence, which can also spur spending. Increased spending will lead to higher incomes and profits that, in a virtuous circle, will further support economic expansion.

I don’t read it that way, and I caught the implication when I first read it. I think it’s clear that Bernanke means to ease financial conditions; and certain events, like higher stock prices, tend to follow suit. I don’t see what’s so controversial about that. It’s what the Fed always does.

In my view, the key part is that the Fed wants to raise expectations for inflation. At the same time, Bernanke wants to assure us that inflation won’t be a problem. Historically, stocks haven’t been hurt by inflation up to a rate of about 5%. After that, inflation is a killer for stocks. In fact, the only thing worse is deflation, and I think that’s what’s on Bernanke’s mind.

So I was all prepared to tell folks not to get rattled by a pullback because stocks are still cheap. I thought we were going to have a buying opportunity. Instead, the market has continued to rally. As I’ve said, the Fed is on our side. They want investors to take higher risks. This should help stocks and growth stocks in particular.

Posted by on November 4th, 2010 at 10:53 am


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