The Fed’s QE: Will it Prevent a Stock Market Crash?

The S&P500 inched up another 0.5% last week on low volume. Volatility dipped slightly, but only because it started the week already about as low as it typically goes.

Interestingly, there was a sight breakdown in momentum and breadth in the S&P on the daily charts. Stock prices look like they could be topping in the short-term: the MACD indicator has crossed bearishly in a very distinctive way. In terms of breadth, the McClellan Oscillator fell notably during the week. So while the overall S&P rise last week, this occurred because fewer leadership stocks did most of the work.

On the economic front, the news has not improved. Factory orders missed in August, and only met expectations for September. The latest GDP results beat expectations, but only because inventories jumped; personal consumption and corporate capital expenditures were very weak. Initial jobless claims were slightly worse than expected. Personal income beat expectations, but personal spending did not. ISM services came in somewhat better than consensus estimates. Consumer sentiment missed by the widest margin since 2006.  Finally, the big report of the week, payroll for October, was mixed. Yes the headline number beat estimates, but the birth/death adjustment added 126 thousand jobs, much more than it does in a typical October. The headline unemployment rate was unchanged at 7.3%. But the worst part of the report was the labor force participation rate, which plunged to the lowest level since 1978, or 35 years! This means that almost 1 million people LEFT the workforce, and is certainly not a sign that the real economy—the Main Street economy—is actually improving much at all. If it were, the labor force participation rate would  be rising, not falling.

The conventional wisdom behind the apparently unstoppable melt-up in US stock markets is that the Fed’s QE program is working. And since there’s no indication that it’s about to be stopped, then there’s no reason not to put more money into stocks with the clear expectation that prices must continue to rise even more.

But a few days ago, one the biggest hedge funds in the world, Bridgewater Associates, asked a question. They wondered what would happen if QE stopped working?

Here’s what they said:

“The dilemma the Fed faces now is that the tools currently at its disposal are pretty much used up. We think the question around the effectiveness of QE (and not the tapering, which gets all the headlines) is the big deal. In other words, we’re not worried about whether the Fed is going to hit or release the gas pedal, we’re worried about whether there’s much gas left in the tank and what will happen if there isn’t.”

Note what they were NOT asking—they were not asking if or when QE would ever stop. Instead, they’re asking if QE will continue to work its magic on stock prices in the future.

And this is a very important point because as John Hussman reminds investors, the Fed WAS easing immediately before and during both the crashes of 2000-2002 and 2008-2009. So Fed easing did NOT prevent major stock market crashes.

And given that almost nobody can predict exactly when a bubble will burst, the choice investors must make, per John Hussman, is to decide whether they want to look like idiots before the crash (because they missed much of the parabolic run-up) or do they want to look like idiots after the crash (because they rode the market all the way down).

Most successful investors look like idiots because they get out too early. Most unsuccessful investors ride the roller coaster all the way up, and all the way down.

Which type of investor are you?

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