Until today, I think investors have overlooked the potentially highly uncertain financial environment after QE2 ends. On Feb 19, I wrote the following blog post:
Also,
I notice today in Barron's that an excellent article appears that deals with the post QE2 era:
Forsyth, Randall W., 2011. What's the fed's playbook for the second half? Barron's, Mar. 3.
This paragraph from Mr. Forsyth's article sums up the chain reaction of capital flows resulting from QE2:
"The Fed's pace of purchases of Treasury securities has roughly been equal to the federal government's sales. While the Fed is, by law, prohibited from buying new issues from Uncle Sam, it is a distinction without difference. The central bank buys outstanding issues from private holders, who can use the cash to buy newly auctioned Treasury notes. That leaves plenty of cash to find its way to risk assets, from junk bonds to stocks. Or even commodities, although Bernanke denies any role for the Fed in the rise in their prices."
Further, the end of QE2 might bring a decline in stock prices for 2011 Q3&4, something I have written about many times:
"Even so, the second-half cocktail of the end of Fed liquidity injections, fiscal cutbacks on the federal as well as state and local levels, rising food and energy prices crimping consumers could be mixed with the heady brew of spurs to capital spending, which could roil the capital markets and slam stock prices."
Given this scenario, which I think is plausible, employment growth will taper off and perhaps the rate of economic growth as well. The private sector needs to take the lead, yet it is unclear if corporations are willing to do so. Rather conservatism rules and wary managers are timid in placing big bets on the consumer making a sustained purchasing spree.
Overall, 3.5% - 4% economic growth seems optimistic to me. A big drop in unemployment seems unlikely. A flare-up in the Middle East that takes several millions barrels of oil production off-line will certainly raise oil prices. Consumers are not in a position to pay $4.00/gal. or more while maintaining current spending.
I continue to believe that stocks are ahead of economic reality. A correction of 10% seems likely before June.
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