Fed Easing and Markets: A Love/Hate Relationship

The GDP revision of 1.8 percent growth in Q1 was another disappointment in a string of economic disappointments in the past two weeks.

With this lethal mixture of low growth/high debt, it's little wonder traders are wondering if some form of QE3 is coming. Many are citing this as the main reason stocks are continuing to hold up so well. As I write this, the CBOE Volatility Index (VIX) is collapsing, to below 16.

Traders, as a rule, despise QE2, but they are perfectly happy to hold their nose and play the trade that has become so familiar: short dollar/long commodities/long commodity stocks.

That has clearly worked, and in fact still works on days when the euro rises and the dollar sinks.

But did QE2 really do anything to help the economy? Ben Bernanke was clearly hoping that lower interest rates would promote housing, lower corporate bond rates, raise stock prices and keep consumers spending.

Did it?

Ned Davis, always a source for insightful analysis, noted that "QE2 was successful in boosting the nominal price of some assets."

He noted that since Mr. Bernanke's Jackson Hole Speech on August 27 (generally considered to be the start of QE2), asset prices have changed as follows:

S&P 500 up 25%

Commodities up 34.9%

Long-term bonds down 7.4%

Housing down 10.1%

Commercial real estate up 0.8%

While commodities and stocks appear to be clear beneficiaries, Davis notes that the P/E ratio of the S&P 500 has also expanded, from 15.9 to 17.3. His point: stock prices have also been influenced by a rise in corporate profits which may have occurred without QE2.

What about commodities? The prices were bid up to offset the decline in the dollar: "a 10% decline in the value of the dollar should result in a 10% rise in the dollar price of the asset to keep the world price the same."

As for real estate, QE2 has had little if any effect, even with 30-year mortgage rates remaining at historically low 5 percent levels.

Davis' conclusion: "On balance, most households are no better off than before the Jackson Hole speech." Any increase in stocks was offset by a decline in housing values: "...there was no real wealth created."

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