Bravo to BTIG’s Mike O’Rourke for penning this takedown of Bernanke’s speech at the National Press Club today.The gist, Bernanke is trying to claim that QE2 has accomplished something it hasn’t, namely that the seemingly solid economy today is somehow owed to the moves from August and September. In fact, the Fed has just jumped along for the ride.
We’ll just hand over the mic to O’Rourke.
So yes, the policy is affecting the stock market really in two ways. One is by — is by through — is by lowering essentially long- term yields and forcing investors into alternative assets. But also because as this process has been working through — and as we have seen both in the earlier episode that, a few months after we began the process, we began to see a stronger economy — this time, we really began this process in August, and now four or five months later we’re seeing a stronger economy. As the markets see the stronger economy materialising, that’s incorporated into expectations about future profits and future economic activity, and that causes the market to rise as well. So it’s a virtuous circle in that respect. Chairman Ben Bernanke 2/3/2011
We are in the camp that the Fed Chairman was the right man for the job when the economy was on the precipice looking into the abyss. His judgment, creativity and courage forged a path to a much better place today than any of us would have anticipated. For that, we will always be grateful. The quote above was the Chairman’s response in the Q&A session of today’s speech to the question of whether QE2 was helping the stock market. All we can say is that we haven’t heard so many inaccurate statements about the financial markets and the economy come out of the Fed Chairman’s mouth since the “subprime crisis is contained.” With that being said, we are not in the camp that believes that QE2 is a disastrous policy, but we are concerned with the Chairman’s inability to connect Fed policy with the financial market reaction when he is specifically attempting to use Fed policy to influence financial market activity.
The time period referenced in the question is from August onward. First, the Chairman asserts that by lowering long term yields, the Fed forced investors into alternative assets, as opposed to Treasuries. Interestingly, however, the move did not force investors into the key asset in question, the stock market. Volume from August 1st through December 31st was down 15% year over year. The volume in the equity futures market was up 3%. Volume in the Treasury futures market, the area investors were theoretically being crowded out of, was up 43% year over year. Volume in Gold and Silver futures was up 23% and 70% respectively. Corn and Wheat futures volume was up 41% and 22% respectively. The list goes on. We are pretty confident these are not the alternative assets the FOMC was trying to force investors into.
It is interesting how the Chairman has now backdated QE2 to August when the replacement purchases commenced, which only prevented the Fed’s balance sheet from contracting as opposed to expanding it as QE2 does. The fact is that QE2 only officially commenced half way through Q4, and if one looks at it from that perspective, then the Fed cannot take credit for the Q4 GDP report. The stronger data we are seeing 4-5 months later started strengthening before QE2. Whatever happened to monetary policy has a lagged effect? There was no doubt the QE2 expectations were out there and started getting priced in, but was that the real driver in Q4? We suspect that if you ask most Americans what prompted the confidence to go out and make the 2010 holiday season the strongest gain since 2004, QE2 will not even rank among the answers. Events like the election and tax cut extensions almost certainly will. If anything, the equity markets simply came along for the ride as the Fed prompted investors to purchase other assets. Remember, August through December were all outflow months, $56 Billion in total for domestic mutual funds. Sure, QE2 did inspire confidence among investors that the Fed was cutting off tail risk, but did the financial markets react in the manner the FOMC intended? Not exactly. The Fed Chairman is confusing coincidence with causality. There is a adage in trading that comes to mind – “I’d rather be lucky than good.”