If QE2 Flops, Will Stocks Dive?

There is a general belief that the pre-announcement of QE2 in late August drove the September-to-Remember rally. The market is in a sloppy, overlapping wave action seems to be somewhat headed higher pending the mid-terms on Nov2 and the expected QE2 announcement on Nov3. This indicates it is churning ahead of those events. It is beginning to take the shape of a converging wedge or ending diagonal, although it is not following the rules, according to the STU. Perhaps it gets to 1220 or thereabouts in a final thrust, but it is behaving as if it will hold up into those dates. If so, we may have a double setup for buy-on-rumor, sell-on-news.

I have already discussed how a Repub victory would likely lead to gridlock, and gridlock may not portend well for stocks. Mad Hedge Fund Trader goes further and characterizes gridlock as a market myth. When the Repubs embraced supply-side economics (aka voodoo economics) in 1980, gridlock with a Demo Congress/Repub President created a dynamic of increasing spending, eschewing the balanced budget, as shown in this chart. Milton Friedman had argued that large deficits would constrain spending increases, and Congress proved him wrong. Bush 42 began to reverse the deficits, and this continued under Clinton, especially after the Repubs took the House in 1994; deficits decreased and we got the fabled balanced budget. Possibly, then, gridlock with an austerity Congress will constrain spending, but after 1994 we had a President willing to triangulate to the center, whereas Obama seems determined to hang onto his reforms.  

Similarly, the Fed's actual QE2 announcement is fraught with risk for stocks. There still is a debate inside the Fed as to how large and committed QE2 should be. At one end Krugman urges as much as $10T; and the other is the feeble talk of a mere $100B. If a large slug of QE2 is priced in, the actual announcemnet may disappoint.

Let's go a step deeper. Krugman's call for $10T QE is not as dangerous as it sounds. The hyper-inflationists hyper-ventilate that this is simply printing money! Yikes!

They need to get a grip. It may very well be that even Krugman's QE would have little effect. John Hussman, coming from a very different perspective, essentially agrees. He starts with the impact of being in a liquidity trap, captured in this chart:

Cutting through the fairly dense econo-speak that surround the concept of a "liquidity trap", what this means is at zero interest rates, a short-term bond is the same as cash. Get a bond that pays no or little interest; why not just get a batch of currency? So when the Fed engages in QE by buying bonds, it is not so much printing money as simply swapping a bond that would have issued anyway for currency. 

Hussman's analysis is interesting in that it challenges the deeply held belief that increasing money is what causes inflation. He shows that as the currency base increases, velocity decreases, offsetting the inflationary impact of more money. Mish does a good summary of the analysis. The implication is that monetary manipulations have less impact than economists take for granted. This explains why QE had little effect to save Japan from its two lost decades. As Hussman summarizes:

Simply put, monetary policy is far less effective in affecting real (or even nominal) economic activity than investors seem to believe. The main effect of a change in the monetary base is to change monetary velocity and short term interest rates. Once short term interest rates drop to zero, further expansions in base money simply induce a proportional collapse in velocity. ...

Quantitative easing promises to have little effect except to provoke commodity hoarding, a decline in bond yields to levels that reflect nothing but risk premiums for maturity risk, and an expansion in stock valuations to levels that have rarely been sustained for long (the current Shiller P/E of 22 for the S&P 500 has typically been followed by 5-10 year total returns below 5% annually). The Fed is not helping the economy - it is encouraging a bubble in risky assets, and an increasingly unstable one at that. The Fed has now placed itself in the position where small changes in its announced policy could have disastrous effects on a whole range of financial markets. This is not sound economic thinking but misguided tinkering with the stability of the economy.

Hussman is now in agreement with Krugman on the impact of QE. Credit Writedowns does a good job of comparing the two arguments:

Krugman says that the result of this equivalence between short-rates and cash means that the Fed’s QE is really just a duration change by the Treasury.  In quantitative easing, as contemplated in this next round, the Fed will be buying long-dated Treasuries. Given the preceding analysis, it’s as if the Treasury started issuing a huge slug of short-term debt and retired a bunch of long-term debt, making short-duration bills relatively more plentiful than ten-year or five-year Treasury bonds. I really didn’t think about it this way until I put the Hussman piece together with my November article.  But Krugman’s characterization of this is true. 

Hussman goes one step further, however. He has a view of what would create inflation, or the dreaded hyperinflation:

One of the most fascinating aspects of the current debate about monetary policy is the belief that changes in the money stock are tightly related either to GDP growth or inflation at all. Look at the historical data, and you will find no evidence of it. Over the years, I’ve repeatedly emphasized that inflation is primarily a reflection of fiscal policy – specifically, growth in the outstanding quantity of government liabilities, regardless of their form, in order to finance unproductive spending. Look at the experience of the 1970′s (which followed large expansions in transfer payments), as well as every historical hyperinflation, and you’ll find massive increases in government spending that were made without regard to productivity (Germany’s hyperinflation, for instance, was provoked by continuous wage payments to striking workers).

My take: the Fed has now created an Expectations Trap: if they fail to deliver the high expectations of QE2, stocks will fall. If they do deliver and it has little impact, stocks will fall. For traders the arbitrage is between the Nov3 announcement and the discounting of future ineffectiveness of QE. 

Comments

[hula]

I don't subscribe to stu so don't know what they're looking at for the ed. I've seen 2 possible counts that look like they follow the rules, one for a complete ed and one for an unfinished ed that has another leg up to go:

http://gi61et.blogspot.com/2010/10/2115-bst-spx-end-of-day-update.html

[vipul garg]

ending diagonal on 1 mn chart!
thats cute

[hula]

I like his 1 min charts. They show the detail. If you want bigger picture look at his 60 min charts showing the ed

[G Glory]

Looks good to me Hula.

If its not on the 1 min its not going to be on the 60 min.

[devlin]

Thanks for the link Hula.

A 1 min chart over an 18 day period - can't see the problem with that.

I agree, both eds shown look valid. I'm hoping its the completed one that's in force so we can get a decent pullback.

[Account Deleted]

S&P 500 Before opening bell: CLICK HERE

[Vipul garg]

Hula
Anyone who attempts labels on 1mn chart is not worthy of being looked at.he is deceiving himself and others

[William Stockwell]

Yelnick: Another excellent article.

I wonder if u are going to give us an article on the
"fraudclosure"? May be a waste of time, as it appears to have been addressed many times, already?

Consensus of opinion seems to be, that it will be swept under the carpet?

[hula]

Vipul: anyone who makes sweeping generalizations without regard to individual merit is not worthy of being looked at and is deceiving himself and others.

[gerryw]

Hulla - lol!!! So true

[G Glory]

Lol!

[Vipul garg]

Hula and fan following ,
Pay absolute no heed to me for i aim to deceive

[Michael]

I think that it is a poor assumption to be made that QE-2 will simply be a re-hash of QE-1, with the Fed buying Treasuries and Mortgages.

QE-2 will most likely push the envelope of Fed authorization, with the purchase of Corporate Bonds and Commercial Paper indirectly via TALF and CPCF.

[Edwin]

SPX MACD bearish cross on the daily chart...good enough for me to go short and ask questions later. Keep things simple for me.

Completely out of long positions...adding shorts and $USD today.

[yelnick]

William, thanks for the kind words and the republishing of this post. On foreclosuregate, lots of noise, little point. The law needs to be applied, and it varies state by state. I doubt this gets shoved under the rug. Instead it appears the banks will try to foreclose as much as they can, doing the reverse of the process that got them into this mess: shovel documents through, and if some get kicked back, shovel them through again. Volume overwhelms the law. And some will fight back and be litigated. The faster they shovel, the more they can foreclose before the victims wise up. Then they work deals with the few that fought back.

[yelnick]

Hula, on the ED: the STU comment is directed at the rally since the end of Sept. Since then, each wave looks like a "3", so an ED should be considered, but the moves fail to follow the guidelines. Interesting is that a whole bunch of indicators peaked on Oct13. It is possible the move since Oct13 is becoming an ED. This is what the chart you linked is showing.

[Wave Rust]

vipul, re: my list ,,,, none of the reasons in comments, usually given for bearish calls or counts are technical.

they are usually some version of those on the list. which is exactly why people have some bias about the economy, or some earnings and quite often, some weird idea unrelated to finance ,,,, remember Prechter's skirt length thing?

it's bad enough to be wrong on the markets, but wrong and for the wrong reasons is really bad.

wave rust

[Wave Rust]

Yel,

"Instead it appears the banks will try to foreclose as much as they can, doing the reverse of the process that got them into this mess: shovel documents through, and if some get kicked back, shovel them through again. Volume overwhelms the law. And some will fight back and be litigated. The faster they shovel, the more they can foreclose before the victims wise up."

You may have discovered the very first 'Shovel ready project'. Somebody call the White House. :)

wave rust

Ignoring whether QE II is good for stocks, I wonder what the Fed could do differently. Tightening money supply wouldn't work, nor would doing nothing. the US is too far across the rubicon to go back and "let 'em crash".

It's getting pretty weird. I can see getting similar results no matter what the Fed does.

imo, that leaves it up to congress and the prez to get it right. Cut spending then cut some more. then see what happens. then cut some more. then cut taxes.

[Wave Rust]

yel,

Cliff Claven is supporting Linda McMahon. :)

that was the actual title of the article. :)

wave rust

[yelnick]

wave, love it! maybe that title ("shovel ready ...") is enough to create a post

On QE and does it matter, the Fed is largely to blame for the roller coaster since 1987 and especially 1997. Pump liquidity, pull back, drop rates, pull back, etc. I give them credit (pun intended) for backstopping the checking accounts to prevent interbank freezeup in Sep 2008. Their QE1 was largely unwinding from that.

There is a lot we should be doing now but a leadership that is intent on a different agenda. Rates need to rise to restore capital formation, since at low rates the issue is not the borrowing cost but the investment return. Instead, US multinationals are investing overseas where the climate is better for returns. So step 1 is to fix the attractiveness of investing in the US, and that takes lower taxes, less regulation, etc. Step 2 is to fix the housing market, which means let the market find a bottom and remove the overhang of future foreclosures. Neither step requires the Fed to do much.

[Whitebear]

There were a lot of bulls turned bears in the last week or two. My question to you is why S&P is not at 1130 yet, which you were predicting days after days after you sold your holdings?

[Roger D.]

Again if it's too good to be true,it probably is. This last leg of "c" should bring in a top in 7 days. Bingo right around November 3rd or 4th.

There isn't a bear with any hair left. The grand supercycle irregular bull market will end with QE2.

Roger D.

[OracleLurker]

this bear is throwing in the towel - gradually since odds still favor a pullback of some sort. But the bid under this market isn't going to be denied for long.

[Jacques DeMolay Operator #703]

I have an intermediate strength level cycle due today. Meanwhile, it's opening night for the triumphant triumvurate and they weren't so triumphant tonight against the Celtics, losing 88-80. Our hallowed Heat were founded in 1988 and yesterday #88s scored five touchdowns in the Monday night game ie 5x88 which by the way is 440 and 4month4days ago was the June 21st summer solstice high.(Yesterday was 88trading days from June 21st also) Gold topped at 1388 and copper possibly is topping at 388. 88 a key number in Social Network. The SanFrancisco Giants won their first overall championship in 1888 and moved to San Francisco in 19(58). Their last World Series appearance was in 2002, 8 years ago. Have I already mentioned that 58 years separated the 1929 and 1987 crashes? Dow did drop 508pts and SP (5)7.(8)6 pts on October 19,1987. Dow with its April high at 112(58). Yesterday's Dow high minus its October 19,1987 close at 1738.73 is 10508 pts. NY Giants were founded in 1925 or 85 years ago.

[trendlines]

Shanghai Composite: Another breakout

Since the breakout above 2700, SSEC has rapidly climbed up to the upper downtrendline. In the past few sessions, there has been yet another breakout - this time above the downtrendline. Take a look at the weekly chart below. Next target is the wave A high of around 3480. However, with the weekly RSI reaching overbought, i'd await confirmation - some form of consolidation around the 3100 level + a successful retest of the line from above - before adding new positions. Horizontal support around 2900.

http://trendlines618.blogspot.com/2010/10/shanghai-composite-another-breakout.html

[Wave Rust]

Yel,
maybe the bottom is in for RE. I have been told that tax assessments of existing properties, 20+ years and older, in some go-go areas are at or below the pre-construction prices when they were built.

That's alarming at first, and maybe prices could go lower, but how much lower is the question. I could see not much lower for older existing propeties, maybe significantly lower for newer properties.

Still lots of property in the foreclosure pipeline but it seems to be concentrated in the same old states. I think it's a very segmented market in those speculative markets.

Some homeowners who are upside down but not much. Then there's the RE that has banks upside down. Banks dribbled out quite a few propeties over the past year or two, and have been the cause of their inventory properties becoming more deeply inverted. A friend lives in a town that has alot of nice homes, $400M +. The bank has sold several in that area for less than $100M.

He bought his house in 1982 for $150M and he just got his tax assessment and his house is now worth $92M. That got me thinking that a bottom was near or in, as to prices. I imagine that bottom process to look like the low volume SPX decline from late '08 to March '09 low.

So, if QE II has any effect by forcing assets to be disgourged from banks by means of foreclosure/short sales, etc. ,,,, that re-pricing of REO and the balance sheet hits for each bank are much easier to take now than it would have been 18 months ago.

If the Fed buys discounted CDO and REO debt from Fannie, Freddie, and FHA/VA, and the banks/loan originators, "The Great Unwinding" could begin.

the 'who wins?' with this scenario is banks and other indirect lenders. The 'Who loses?' is easy.

QE II pumps $1 trillion in, the RE price crash doesn't happen, and inventory begins to sell. I say, get somebody to lend to the spec RE traders. they'll get the market moving.

it's always bleakest when it's sunny in Philadelphia.

wave rust

[hula]

yelnick - thanks for your clarification on the ed that STU is talking about.

[Account Deleted]

S&P 500 Before opening bell: CLICK HERE

[Edwin]

RE can and will go lower for as long as our next generation is having less economic successful than their parents and when 86% of college kids return home to live with their parents. It is all about the lack of the prosperity for the next generation at large and America will continue to sink accordingly.

[Edwin]

SIT TIGHT on SDS and $USD...

more technical damages done to SPX as its RSI uptrend is broken today. and Full Stoch. %K drops below 66.6

[Dsquare]

Trick or treat, gold stocks
http://img59.imageshack.us/img59/139/huioct2710a.png

[Wave Rust]

edwin,

RE isn't a next generation problem. it's simply a problem that is not resolved yet.

the next generation is lucky to be getting this education ,,,, this very valuable lesson about asset investing, whether it's RE or in securities.

I have never seen the 'wished for' instant prosperity that a college education is supposed and assumed to hold for the younger adults. That prosperity silver platter is a myth to anyone who has a college degree. It takes work, both in good times and bad times.

I propose that young people learn to control their emotional reactions to the economy, regardless of its condition. A long unbiased look around at the local community will eventually see the bright spots amid all the doom and gloom in bad times. In good times, that same long look will see the seeds of eventual down turns ahead. Staying flexible and objective about one's potential options is the essence of living a successful life.

Abandon negativity, the naysayers, within your circle of contacts and friends ( keep one or two negative people who are always wrong who become great fades).

Young adults, and anyone else too, need to learn that the people who speak words like, "You aren't such and such" or "You can't possibly believe such and such", should be dropped from any further interaction.. Those people are not on your side.

I have done it many times over the years. I have never regretted it for a moment. Ask yourself this Edwin. Are you one of those negative people influencing a young person and their future desires and aspirations?

If you are, then I suggest you start becoming a positive force, even if you have to fudge your negative feelings. Why? If you are negative, then you certainly have lots of people who agree with you. And, why is that? Well, the old adage of "Misery loves company!" is eternally true.

Consider looking around at how many great companies were started and grown at any of the miserable economic lows, from the 30's forward.

This is the easiest time to start a brick and mortar business.
This is the easiest time to start and grow an internet business anywhere in the world.
It's truly a generational time, a once in a lifetime opportunity for young people to get into new start ups, or young 2-4 yr. old businesses.
And, I don't mean high tech. I mean the standard local businesses that have survived this economic downturn.

One of the most positive "can do" kids I have seen grow up around me, has moved from entry level tech to interim head of his radiology dept at the biggest hospital in the metro area where he lives. He is an 'interim' because of having only a 2 year A.S. degree, but he's getting paid the full salary. He's done this in just under 3 years!

I just saw him on Labor Day weekend. He came home to introduce his fiance to people at home. He is on his chosen path to success as a man and as an employe. And, he's in love with a great lady.

He was always positive because he had parents who were positive, even in their most desparate days. And, they had some difficult times.

Stay positive and discard those who aren't.

wave rust

[Edwin]

wave,

Thanks for the inspiring words. I will pass on your comments to the younger men and women around me.

[Dsquare]

Stay positive but resist!
Thank God for France
http://www.zerohedge.com/article/thank-god-france

[Greg]

Prechter is consistently wrong. This guru is the PERFECT contrary indicator. A couple of days ago he went SHORT TERM bullish, guess what, we got a correction in our hands. He is unbelievable. Now he nails the market even short term. I am thinking to subscribe to this guy.

[yelnick]

wave, more than half the "sales" are foreclosures and oddly enough they will keep prices up in that they get priced at mortgage value. as the foreclosure wave peaks we may see further downside in housing - bargain hunters first, those buying foreclosure sales at discounts. at some point after that we should see the bottom. housing follows a cycle of sorts which suggests the bottom is not close.

[yelnick]

hula, curiously, the weakness today would fit an ED end yesterday

[Wave Rust]

Yel,
I assume you mean at a percentage of mortgage value because that is already happening in non-CA America. :) CA is always last, as I remember, out of the housing ditches. Last In and Last Out seems to keep CA's RE prices nearer the median level before the next bubble.

yeah, the housing cycle always does its parabolic thing in about the last 10% of the 20-22 year cycle. Parabolic rising and parabolic falling is all that anybody remembers. They forget the other 18 "normal" years.

the bottom may look alot like Neely's wave E's that don't go to new lows. That's why I said the bottom for prices may be nearing.

Do you remember the early 80's when "nobody" could get a loan, neither at 20% in 80 and 81, nor at 6% a couple years later? I do. People who wanted a home loan needed a co-signer with good credit. That may be the new normal for a few years, as well as other creative financing tools that few are now using.

I guess I'm just starting to look for the opportunities in times of crisis, as a capitalist. It's a capitalist's primary responsiblity - find a need and fill it without injury to another. If the other party is already injured, then "Ease their pain", ala 'Field of Dreams'. "Mr. Banker, what burden may I remove from your daily load?"

Take a load off Annie Banker. :)

wave rust

[Wave Rust]

Edwin,
Encourage all and be of good cheer. :)

The young have been bombarded for years with how bad it is ,,, you have no hope, etc.

The cruelty is that those who are bombarding them KNOW that the kids have no personal real life historical frame of reference. The kids haven't seen the cycle of ups turning into downs and then back to ups, and so on.

The bombarders are aware that they can influence the independent thinking right out of kids. Sometimes it's teachers, professors, textbooks and popular media, or a boss at a some burger flipping job.

That is malicious and intended for some nefarious purpose. Somebody has to counter that.

I do. I encourage everyone to be positive. No matter where you live in this world.

wave rust

BTW, when I'm bearish, I am NOT negative. I am positively bearish, until otherwise indicated. LOL

[Sobranie]

Wave, being positive is a good thing, on that I agree..

But take a look at the last year's run up. Its been 16 months of a 60% gain.

Like you have said. Cycles.

Getting in now for the kids might be a bad idea. Not that I am old enough to call anyone past HS a kid, but you know what I mean.

[Edwin]

UUP volume 15+ million. wow! $USD bottom is in. More upside ahead.

[Roger D.]

JNK is near a turning point.

Roger D.

http://www.screencast.com/users/parisgnome/folders/Default/media/b8de8f60-dead-4eb6-9fb3-c6e11c739ada

[Whitebear]

"Prechter is consistently wrong. This guru is the PERFECT contrary indicator. A couple of days ago he went SHORT TERM bullish ...."

Well. If you want to bash Pretcher, at least bash him with the correct facts.

He turned bullish on Oct 20, when S&P was still at 1170. S&P is still at 1183 today. Also, explain to me if Pretcher is such a contrarian, why the market was dropping > 100 pts today and managed to close at just 40 pt below? Why? How come Pretcher being bullish failed to drop the market?

[hula]

Yelnick - I was really busy at work but was watching the markets intermittently. We started off well for the ed top count. Shame we didn't get a more bearish close. Seems to keep more bullish options open.

[coolio]

anti-prechter is an excellent signal, very long and impressive record

no joke

I have no idea why prechter is so consistently wrong. It is really weird. Weirder, perhaps, than the Jimmy Carter rabbit thing.

[yelnick]

hula, the ED is only in wave 4 .. it needs a 5 to finish. It started on OCt13, a date a to of things reversed. he last few EDs have all come with some govt event pending (bear stearns, GM). This one is heading tight into the QE2 announcement in a week.

[OracleLurker]

from EWI -

We use our analysts' brain power to generate the wave counts for our publications. We feel that none of the wave-counting software packages on the market today are consistently reliable. For that reason, we continue to work full-time on the development of our proprietary EWAVES (Elliott Wave Analysis and Validation Expert System) application.

Just how long have they been working on this?

[Greg]

Whitebear, I am not sure I understand what you are talking about. A couple of days ago Yelnick wrote Prechter turned short term bullish. And the market (ignoring levels that support ANY argument) is in a correction. About 10 days ago he came out and said the dollar "SEEMS"(talking about conviction) or APPEARS to be bottoming. RIGHT AFTER his call, EUR (to keep things simple) RALLIED from 1.37 to 1.405. One can hide behind the SEEMS and APPEARS but try to say that to a currency trading... In any case, I am not here to shake up your belief system, after all religions exist for centuries for a reason. If you want to convince your environment Prechter is right in order to deal with reality I don't mind to concede just to help you.

[Greg]

"from EWI -
We use our analysts' brain power to generate the wave counts for our publications. We feel that none of the wave-counting software packages on the market today are consistently reliable."

I fully agree. Only EWI is CONSISTENTLY reliable. It is the best contrary indication one can get out there.

Regarding "brain power" I agree also. It is NOT EASY to be CONSISTENTLY WRONG, actually it's as difficult to be consistently right.

[OracleLurker]

If only they could program their proprietary EWAVES to be as consistent.