Monday, November 8, 2010

The Law of Unintended Consequences

A cautionary posting for you today.

If you plan on taking advantage of QE2 in the stock market, remember that history does not repeat... it does but follow similar patterns.

A subtle, but crucial distinction.

When it was first announced I expected much of QE1 to find it's way into all segments on the stock market. Which is why, back on March 12th, 2009 I said, "One thing is for certain, all this money printing is going to juice the economy in the short term like nothing any of us have seen in our lifetime. Look for commodities in the stock market to take off like a rocket."

The stock market has gained back 60% of what it lost in September 2008.

Back in late August 2010 the Federal Reserve announced QE lite and promised QE2. What has happened since then?

Essentially we are in an inflation trade melt-up.

Everything that is an inflation hedge has exploded since late August. Gold is up 15%. Silver is up 48% (courtesy of the manipulators finally getting taken to court). Agricultural commodities are up 25%. Oil is up 20%.

And stocks?

Stocks are only up 17%.

Right now money is flowing to commodities, especially precious metals and agricultural commodities, as well as emerging markets.

The Federal Reserve's continued goosing of equities is (by Mr. Bernanke's own admission) designed to spark a "virtuous cycle" in which a rising market lures investors in, further driving up prices, which creates new wealth which then triggers "the wealth effect:" people who see their 401K accounts swelling will open their wallets and spend, spend, spend.

But the folly of this approach is already getting push back as this Wall Street Journal Op-Ed by Kevin Warsh, Federal Reserve Board Governor and former member of the President's working group on capital markets.

  • "But if the recent weakness in the dollar, run-up in commodity prices, and other forward-looking indicators are sustained and passed along into final prices, the Fed's price stability objective might no longer be a compelling policy rationale. In such a case—even with the unemployment rate still high—we would have cause to consider the path of policy. This is truer still if inflation expectations increase materially."

Much of the rising values in the stock market have come as volume drops. It appears much of the 'gains' are coming solely on the back of Federal Reserve injections of POMO.

In 2010 individuals have withdrawn $92 Billion from mutual funds.

As I said on the weekend, the watchword for what lies ahead is volatility. We are going to see violent swings in all areas.

Be aware and beware.

History is governed by the Law of Unintended Consequences.


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