This blog post originally appeared on RealMoney Silver on Oct. 19 at 9:13 a.m. EDT.I find myself back to taking the (market) road less traveled once again as investors' unjustified blind faith in the success of QE 2 has increased the U.S. stock market's degree of risk relative to the reward. Let me start by emphasizing that the precision of stock market forecasts in a market dominated by algorithms, momentum players and even mob psychology is an increasingly difficult exercise, but I will try nonetheless. In early July 2010, when the S&P 500 was plummeting and closing in on the 1,000 level, I suggested that the scale had tipped to the bullish side and that equities were in the process of making the lows for the year. Since then, buoyed by the notion that the prospects for an open-ended QE 2, which would be aimed at lowering real interest rates, raising inflation rates and have a strategy that might even be targeted at the S&P 500 in order to elevate the U.S. stock market, equities have leapt forward for weeks in a routine and consistent fashion. In light of what I expect to be a disappointing economic impact from QE 2 -- I call it quantitative wheezing -- and the negative consequences of that strategy ("screwflation") on the majority of Americans, I now believe that equities are in the process of putting in the highs for the year. After spending like drunken sailors during the Bush administration, Republican legislators have acknowledged that it will block even the most sensible stimulus programs, and the Democratic administration and its legislators have lost the will to fight their adversaries. As a result, the responsibility for turning around the domestic economy now lies squarely on the shoulders of the Fed. The implementation of QE 2 during the first week of November is now a virtual certainty. The general belief in its efficacy has vaulted stock markets around the world considerably higher.
Most market participants are fixated with the potential for QE 2 to boost asset prices and generate organic economic growth, however, without a subsequent rise in aggregate demand and productivity, the program will ultimately be deemed a failure as prices readjust over time to reflect the real underlying fundamentals. Mr. Bernanke is making the same blunder that we made with the past bubbles busts -- if we can create paper profits and convince consumers that they should spend those paper profits, then we'll be on our way to economic prosperity. The problems arise when asset prices readjust lower to meet their true fundamentals. It's Ponzi finance and nothing more. -- " Northern Trust: QE 1 Failed, Why Will QE 2 Work?" from Pragmatic CapitalismAs I have written previously, I don't believe QE 2 will meaningfully move the needle of domestic economic growth and will only have a limited impact on:
- the jobs market, which is plagued by structural unemployment;
- housing, which that is haunted by a large shadow inventory of unsold homes and in which mortgage credit will likely be further reduced by the moratorium on foreclosures; and
- confidence, which is still mired in uncertainty regarding regulatory and tax policy (and that is undermined by high unemployment).