While Frontier Advisors is about the long-term evolution of the markets, we still need to consider the short term risks to the economic environment so I do spend considerable time (too much, I’m sure) thinking about the issues of the day. Lately there has been significant discussion about a second round of monetary stimulus from the Fed, termed QE2. The US markets are clearly in favor of more monetary stimulus, bidding up prices any time a member of the Fed’s policy-setting committee even hints of it. While I am not as convinced as most that QE2 is imminent (I do think it is likely, however), I am even less convinced that it is necessary or at all helpful to our current situation.
My explanation is rather simple. We are facing an extreme lack of confidence in our economy, and not only will more monetary stimulus fail to cure that lack of confidence, it may actually give us another reason or two to lack confidence even more. Consider some of the reasons behind this lack of confidence:
- Uncertainty about future taxes
- Uncertainty about the cost of healthcare
- Uncertainty about the vaguely-written financial reform package
- Uncertainty about who will be in power after the November elections
- A gargantuan and growing deficit
- Near bankrupt state coffers
- Official unemployment near 10% (and true unemployment likely far higher)
- An impending currency war
- Little progress in housing and/or mortgages
Pumping more liquidity into the system offers no solution to any of the above and may actually exacerbate a few of them. By all accounts, businesses are awash in capital right now, hoarding it until they see a good reason to put it to work. Individuals, on the other hand, may have capital to spend or may not, but asset purchases by the Fed are going to do nothing to change an individual’s cash position, nor will they convince him or her to head to the mall and spend any more than they are likely to already. Add to that the concerns of Fed Chairman Ben Bernanke himself that “we are still learning about the efficacy and appropriate management of these alternative tools” and it seems clear that further stimulus at this time does not make much sense.
Unfortunately, the market has already priced in additional stimulus measures. Therefore, if the Fed does actually decide to do nothing for now, the market will react negatively once it figures out it guessed incorrectly. We are clearly in a damned if you do, damned if you don’t situation that requires patience and an ability to stay the course while the powers that be navigate these waters as best they can. The only thing that to me seems certain is additional volatility in the markets. Let’s hope it has an upside trend to it.