In his latest note, John Hussman addresses the topic du jour, the end of QE2. Not surprisingly, given his bearish stance, he’s not sanguine about the prospect of the market (or the economy) holding up once that program wraps up.
Still, barring a surprise early-conclusion to QE2, there are two important issues for the market as we look ahead to gradual changes in Fed policy.
First, what happens when QE2 is complete? From our standpoint, it is incontrovertible that the primary factor behind the market’s recent advance has been speculation based on the belief, explicitly encouraged by Bernanke, that the Fed would provide a backstop for risk-taking. Investors clearly took Bernanke at his word. But without yet another round of QE, not to mention the potential for an unwinding of existing QE, a decline in speculative enthusiasm will likely have the identical effect as an increase in risk aversion.
Second, how likely is it that economic growth will be successfully “handed off” to the private sector as fiscal policy tightens and monetary policy becomes less aggressive? It is clear that the economy is enjoying some surface economic progress – the most notable being a gradual drop in new claims for unemployment. But the real fiscal “cliff” for states and municipalities doesn’t hit until about mid-year, which is the same time that QE2 comes off. What we’re observing at present is decidedly still fiscal- and monetary-induced growth. It is not enough that the data have improved gradually. The real question is whether it would have, or will, improve without that stimulus.