Race to End QE2 Hangs Over Stocks

The recent remarks of the St Louis Fed President James Bullard have made it clear he believes it is time to think seriously about an exit strategy from the second round of quantitative easing and this could have big implications for stocks, according to one economist.


"Mr. Bullard's eagerness to claim that the economy is 'pretty good', when clearly it is not, may simply represent his attempt to stage an orderly retreat from what has been a disastrous QE2 policy," Stephen Lewis, the chief economist at Monument Securities in a research note.

"Since QE2-related liquidity has probably been the chief factor fuelling the rebound in global equities, its impending end carries serious implications for future equity performance," Lewis wrote.

With stocks so far shrugging off the so-called wall of worry, many investors are betting that first-quarter earnings will beat the street, but Lewis is worried that corporate outlooks could disappoint due to some worrying signals from US economy.

"The consensus appears to be that stock prices are reflecting signs that the global economic recovery remains intact, despite blows to market sentiment from political turbulence and natural catastrophes," he wrote.

But Lewis added that he was not convinced by this view and that US growth is slowing from the fourth quarter of last year.

"New and existing home sales, housing starts and home prices have all been reported as on the slide. The weakness in US activity extends beyond housing," said Lewis.

"Durable goods orders for February undershot expectations and almost all measures of consumer confidence, after showing some improvements in the early weeks of this year, have since slumped, probably in response to the negative impact of rising gasoline prices on households' real spending power," he added.

The Chinese and Japanese are also slowing to varying degrees and QE2 is driving price rises in areas that are bad for consumer sentiment, according to Lewis.

"The Fed's monetary stimulus, especially its QE2 exercise, has been aimed at keeping prices on a rising trend, that is, at preventing deflation," he said. "But the prices that are rising most sharply are ones that add to the essential costs of US households and companies, and also contribute to global political instability."