Stocks and QE All Things Must Pass

Stocks And QE: All Things Must Pass [SPDR Gold Trust (ETF), SPDR S&P 500 ETF
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Stocks And QE: All Things Must Pass

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Stocks And QE: All Things Must Pass [SPDR Gold Trust (ETF), SPDR S&P 500 ETF Trust, iSh...
Oct 17 2013, 02:54 | 39 comments by: Eric Parnell | includes: EEM, EZU, FXI, GLD, HYG, JJN, JJU, LQD, PFF, SLV, SPY, TIP, VNQ BOOKMARKED / READ LATER
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Added to your bookmarks on the Seeking Alpha homepage Remove Bookmark Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. (More...) "Sunrise doesn't last all morning A cloudburst doesn't last all day Seems my love is up and has left you with no warning It's not always going to be this grey All things must pass All things must pass away" --All Things Must Pass, George Harrison, All Things Must Pass, 1970 The shutdown and debt ceiling debacle in Washington is finally over. And despite all of the talk about the tensions in financial markets over the political wrangling these last few weeks, the stock market was largely unmoved through it all. In fact, it emerges in the aftermath a mere hairsbreadth away from fresh all-time highs. The performance and resilience of the stock market these last few years has been undoubtedly remarkable, and perhaps it will persist into the future. But before jumping on board for the next potential rally higher, it is prudent to consider after so much time exactly what has been driving the stock market to this point and how much longer it is likely to continue. For the one thing we know for certain is that eventually all things must pass including the current bull market in stocks. And one certainly does not wish to be caught unaware when the love is up and the stock market has left us with no warning. The stock market rally is currently running on 56 months and counting having begun in March 2009. This already ranks it among the longest lasting cyclical bull markets over the last century. With this in mind, it is worthwhile to examine the fundamentals behind this rally to assess its sustainability into the future. A number of forces are typically critical in supporting sustainably rising stock prices.
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Leading among these is the health of the underlying economy. This, of course, can be measured through the trend in U.S. Real Gross Domestic Product. And while the economy and stocks have been advancing higher together since early 2009, it is worth noting that stocks have raced ahead of the underlying economic growth trend since late 2012. The two past instances during the current cyclical bull market rally when stocks moved ahead of the economic growth trend, they subsequently corrected to return back to trend. Thus, a short-term correction in stocks would certainly not be beyond the realm of possibility at this stage on this point alone.
(click to enlarge) The strength of the underlying economy plays an important part in driving corporate revenue and earnings. And it is in this regard where the sustainability of the current cyclical bull market starts to come under increasing scrutiny. In regards to sales growth, after a strong advance in the early stages of the post crisis recovery, it has effectively stalled over much of the last two years. But stocks have advanced strongly over this same time period, thus vaulting stocks well beyond the relatively weaker sales growth trend.
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(click to enlarge) The same can be said of corporate earnings. After recovering smartly in the first three years of the post crisis period, profit growth has essentially ground to a halt over much of the last two years.
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(click to enlarge) All of this is notable for the following reason. The stock market began 2012 trading at 1257 on the S&P 500 Index (SPY). By the middle of 2012, stocks had effectively revisited this price level. But only 16 months later, the stock market is now trading at fresh all-time highs of 1721 on the S&P 500. In other words, we have seen the S&P 500 Index increase by an astounding 464 points, or roughly 37%, in less than an year and a half despite a sluggish economy that included little in the way of sales growth and virtually no earnings growth. This suggests that investors are now willing to pay 37% more today for what is essentially the same stock market they could have bought a little more than a year ago at a much lower price. Putting this into perspective, would you as a consumer be willing to pay 37% more today for the same television or automobile that you could have purchased a year ago? Most consumers would balk at such a proposition. But when it comes to the stock market, investors seem increasingly eager to buy the product the more expensive it becomes. So exactly what explains the continued rise in stock prices over the last 18 months despite the fact that underlying fundamentals have all but ground to a halt? The answer is balance sheet expanding monetary stimulus program known as quantitative easing (QE) from the U.S. Federal Reserve, of course. The Fed & Stocks: A Torrid Affair "What I feel, I can't say
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But my love is there for you anytime of day, But if it's not love that you need Then I'll try my best to make everything succeed" --What Is Life, George Harrison, All Things Must Pass, 1970 The Fed's devotion to stocks remains unwavering. Since the beginning of the financial crisis, the Fed has tried its best to make everything succeed for the stock market. And the moment we have even the hint of any trouble for stocks, the Fed's love is there anytime of day through speeches, daily asset purchases and general words of uplifting support.
(click to enlarge) What is the stock market's life without the Fed's love? Not very good at all as it turns out, as it seems that stocks are the tempestuous one in the relationship. For the moment the Fed has walked away from QE related asset purchases, stocks have quickly tumbled sharply lower within 15 trading days after the Fed has left on average. A torrid affair indeed. But while romance is always exciting, some critical questions must be raised about the substance of this relationship between stocks and the Fed. For like so many wild relationships, they often end badly unless it can evolve into something more sustainable and real.
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Unfortunately, the Fed's track record with its other post crisis dalliances across various other asset classes suggests that it may only be a matter of time before the high profile affair between stocks and the Fed's QE ends badly. For U.S. stocks are far from being alone in getting caught up in the Fed's QE spell. In fact, stocks from around the world found themselves caught up in the Fed's QE trance. And through the summer of 2011, they were all enjoying a similar ride higher. For example, stocks across the much beleaguered euro zone (EZU) were on the same trajectory before suddenly breaking up and never truly being able to get back together.
(click to enlarge) The same can be said of emerging market stocks (EEM) including major countries like China (FXI). After rallying along with U.S. stocks through the summer of 2011, they have broken down and flat lined ever since.
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(click to enlarge) Even a number of major stocks within the U.S. have fallen off of the QE road higher over time. For example, mega-cap companies like Ford Motor (F), Apple (AAPL) and ExxonMobil (XOM) all found themselves deviating widely from the path set forth by the Fed's QE during the 2011 to 2012 period.
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(click to enlarge)
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(click to enlarge) And more recently in 2013, income generating areas of the market such as real estate (VNQ), high yield bonds (HYG), preferred stocks (PFF) and AT&T (T) have all broken away to the downside while the investor romance with the overall stock market in general continues without seemingly a worry in the world.
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(click to enlarge) The notion of inflating asset prices should also fall directly to the benefit of the industrial metals and precious metals complex, but this has been anything but the case in recent years. The price of copper has been flat at best for several years running much to the dismay of major producers such as Freeport McMoRan (FCX) and BHP Billiton (BHP), while other major base metals such as aluminum (JJU) and nickel (JJN) have fared even worse.
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(click to enlarge)
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(click to enlarge) Gold (GLD) and silver (SLV) have also suffered mightily despite the fact that record volumes of fiat currencies have been printed by major global central banks in recent years. So while one would be hard pressed to come up with a better fundamental environment suited to support rising precious metals than what we have today, the underlying price performance of these metals has recently been abysmal despite ongoing QE.
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(click to enlarge) Even the more conservative asset classes have lost their way in following QE higher in recent years. For example, traditionally more stable and predictable investment grade fixed income categories such as TIPS (TIP) and Investment Grade Corporate Bonds (LQD) have recently been cast aside by the QE trend.
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(click to enlarge) Mortgage REITs such as Annaly Capital (NLY) that had long been beloved by income seeking investors and had moved in lockstep with the QE curve for much of the post crisis period have also recently found themselves kicked to the curb from this relationship in recent months.
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(click to enlarge) Ironically, the only major asset class that has traveled its own path largely independent of the forces of QE is the one that the Fed has claimed that it is trying to directly influence with its asset purchases. This category, of course, is the U.S. Treasury market. But despite the lack of correlation to the Fed's balance sheet expansion, it too has been suffering over the past year.
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(click to enlarge) These are only a few of the many examples of stocks and asset classes that were also once wedded to the upward trajectory paved by the Fed's ever expanding balance sheet thanks to QE. And they all provide a critically important lesson for investors that markets can be most fickle, and stocks seem most overdue for a break in this same regard, particularly given the lack of real fundamental support behind their advance to this point. Investor Heartbreak Ahead "Isn't it a pity, now, isn't it a shame How we break each other's hearts and cause each other pain How we take each other's love without thinking anymore Forgetting to give back, isn't it a pity" --Isn't It A Pity, George Harrison, All Things Must Pass, 1970 All of this is highly problematic if not dangerous for investors for the following key reason. Many stock investors are now completely driven by one key assumption: as long as the Fed is applying QE stimulus, stocks will rise and nothing else matters. Unfortunately, this basic "if QE, then rising
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stock prices" conclusion is grossly misguided. For while this has been true so far, it does not necessarily mean that this relationship will continue to hold into the future. And one has to look no further than the heartbreak so many other asset classes have already suffered at the expense of this overly simplistic assumption. As a result, those investors that ignore the fundamentals and simply try to take the Fed's stimulus love without thinking anymore increasingly stand the risk of becoming the greatest fool by buying in as the market is finally topping out. And this could happen today, a month from now or a year from now. Just as with the bursting of the technology bubble in 2000 or the housing market in 2007-08, nobody exactly knows when it will finally take place. But the break up for QE and stocks is coming. It's only a matter of time at this point. Disclaimer: This post is for information purposes only. There are risks involved with investing including loss of principal. Gerring Wealth Management (GWM) makes no explicit or implicit guarantee with respect to performance or the outcome of any investment or projections made by GWM. There is no guarantee that the goals of the strategies discussed by GWM will be met. 39 people decided to get JJU articles by email alert Get email alerts on JJU
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More articles by Eric Parnell Stocks: The Waiting Is The Hardest Part Sun, Nov 3 The Real Crisis For Washington And Wall Street Thu, Oct 10 Stocks And The Fed: Why I'm Staying In Cash Thu, Oct 3 Stocks: Strategies For A Challenging Decade Ahead Wed, Sep 4 Comments (39) Register or Login to rate comments Rico Kastilani Comments (128) Great article Eric! I also like the layout: Simple and to the point. 17 Oct, 03:08 AMReplyLike5
Interesting Times Comments (6289) Eric Think this will be on the evening news? I borrowed a post from someone I respect....Makes you think doesn't it?? "This item was brought to our attention by double guns on the QC. There is speculation that we may be entering a hyper inflationary environment. I'm continuing to add physical silver and increasing the cash allotted to it. The debt increased $328B dollars in one day. JP Morgan Chase has issued letters to its business account holders notifying them that as of November 17 the bank will limit all cash transactions, including deposits, withdrawals and ATM usage, to $50,000 per month, and will prohibit all outgoing international bank wires. Chase Bank has moved to limit cash withdrawals while banning business customers from sending international wire transfers. This has caused speculation that the bank is preparing for a looming financial crisis in the United States by imposing capital controls. We have seen this before in Cypress and Greece read more here. http://bit.ly/19Rp25D SMaturin on the QC contributed substantiation. http://bit.ly/19Rrrgu " 18 Oct, 09:11 PMReplyLike1
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tawse57 Comments (335) Doesn't history teach us that financial crisises come out of the blue and take the banks completely by surprise? As they missed several of the last bubbles and subsequent collapses why would they suddenly have wised up? 19 Oct, 04:19 AMReplyLike0
Interesting Times Comments (6289) @TAWSE57 Not so sure the banks missed the bubbles. I am sure most retail investors did though. Go back to the day the FED announced NO TAPER when all expected it was going to happen. Now look at gold. It started to tick upwards very quickly minutes before the announcement. Was that info leaked? FBN'S also commented on golds movement just prior as well. Nope, I think we live in a different era after 2009 when the banks were used by the FED to bail out the country. They are now privy to inside info . Favors owed back now being repaid!! Watch the movie TOO BIG TO FAIL if you haven't. The puzzle might make more sense. Gold is being manipulated openly and nothing is being done about it either. Just visit my blog and read some of the comments. But here is one of them.. "Traders befuddled by short, sharp movements in gold prices Gold traders have been puzzling over a series of massive transactions over the past three weeks that have caused the price of bullion to move sharply within a matter of minutes. The latest incident came in the wee hours of yesterday morning in New York, when a wave of orders to purchase $2.3B worth of gold caused the metal to spike 3% in just 10 minutes. Theories about what's causing the phenomenon include the effects of 24-hour electronic trading, short covering, selling by a distressed fund
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and deliberate market manipulation." MARKET MANIPULATION???? Humm........ Here is our latest chapter and Eric has dropped in from time to time to comment here as well. http://seekingalpha.co... Everyone can feel free to join in and we also have a portfolio challenge going where you get 100k and make any trades you like. If interested in joining in and getting the link feel free to ask in a PM or look under my moniker for the latest chapter on the portfolio challenge!! Hope to see some new faces commenting daily as we are all friendly and bounce ideas off each other.. My 2 cents. 19 Oct, 11:59 AMReplyLike0
newbeach861 Comments (35) Another great article, but I always have one question by the end, which is due to my ignorance, which the article fails to cover. The question is who is investing in stocks who is not investing in the other asset classes you list? The average Joe n Jane is simple enough. but I am told they are not playing this game. 17 Oct, 04:35 AMReplyLike2
jmrx Comments (5) I too am wondering but I have the feeling it is the mutual fund managers, hedge fund managers, and the like. They are all feeling good with
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the current results and will ride the wave until it breaks. I wish the markets could trade on fundamentals and not driven by the big money this would give all of us little people a chance who make decisions based on information relative to the operations of the companies we invest in. 19 Oct, 10:29 AMReplyLike0 La Marque Comments (1298) The private sector savings plans (401k) along with the public sector plans (403b) are taking in money and placing most of it in mutual funds whose managers don't like holding cash is one major reason for the growth of the stock market. 19 Oct, 11:54 AMReplyLike0
A Brylewski Comments (2) Like the theme "All things must Pass" and agree with the important message you are sharing. This market is just crusin along staying irrational longer than I have expected. Top line revenue at a lot of companies is faltering yet we just keep pushing higher. At some point this market will correct. One can only think the longer we don't the harder we will fall? 17 Oct, 08:12 AMReplyLike1
coindog Comments (381) great charts, they really are worth a thousand words. good job in putting up separate ones instead of filling one with 15 lines. a revert to the mean always happens, usually with on overshoot. when is the question. 17 Oct, 10:53 AMReplyLike4 perplexedtex Comments (524) Thanks, Eric. This was a logically written essay that should encourage equity investors to raise cash. I like Beatles, Stones, Animals and Dylan. Please feel free to use their lyrics in future articles. 17 Oct, 11:06 AMReplyLike3
wolfosc Comments (35)
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Awesome. Thank you. 17 Oct, 11:18 AMReplyLike2
La Marque Comments (1298) A 5 Star article! Kudos! 17 Oct, 11:29 AMReplyLike2 Salmo trutta Comments (1081) The mal-distribution of investment/overinvestment (financial transactions & not real-investment) that took place up until 1929, is being simply being repeated. 17 Oct, 11:41 AMReplyLike1
mobyss Comments (1326) No, I don't think so. That is, that QE will end. The Fed made some noises to that effect in the spring, and look what happened. With Yellen taking over, I really believe that some form of QE will probably be with us for at least the next four to six years. Yes, years. This "recovery" would still be a 4.5 year recession (depression?) but for one factor - QE. If things were normal, we'd be closer to the next recession than we are from the last, but since QE life support is going to continue well into the time that recession should happen, we might not see it at all. The pressures and distortions will continue to grow. Like you show, many asset classes are already diverging from Fed balance sheet expansion, except for the one that "matters" - the stock market. This is the one and only high-profile tool the Fed (and government) have to try to convince people that there is any recovery at all, and once they lose that, there is nothing left but cold hard reality. Who knows what to do now. Buy into the markets at all-time highs and extended PE's? Hold what you've got with a 6 to 8% trailing stop and be ready for a drop? Sit in cash and wait for another 2002 or 2009 buying environment?
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The only concern is that at some point the QE drug doesn't do the trick anymore. I think that the Fed might be more concerned with being an emperor seen with no clothes than causing a stock bubble, and that's why they might stop QE - to preserve the impression that they have the power to guide the economy to some magical, prosperous, stable place. 17 Oct, 01:12 PMReplyLike7
Atkins Comments (852) I think you're correct, mobyss. QE is far, far away from ending. The remainder of your points are also valid. What to do now? Good question. Going all-in on mo-mo stocks has worked extremely well for the past two years -- That's a long time for that sort of strategy to continue to bear fruit, but I frankly do not see any semblance of a return to reality in the foreseeable future. Gundlach's comments on TSLA, et al., earlier today are well-worth reviewing. I think his assessment is spot-on. 17 Oct, 04:24 PMReplyLike1
Salmo trutta Comments (1081) That's why opportunists chart. What nobody's figured out is that the Fed's research staff, academics, & other professional players don't know the difference between money & liquid assets. The short-end segment of the yield curve is inverted per IOeR policy. The FED pays a subsidy to the commercial banks not to lend. Then the regulators flatten the yield curve destroying net interest margins: http://bit.ly/WbVzih I.e., with margin compression, the only place for interest rates to go is up. This is extremely simple. Unless money expands at least the rate prices are pushed up, employment will be cut. But unless savings are matched with real-investments, the U.S. will go broke rather quickly. 18 Oct, 01:00 PMReplyLike2
Mitch Zeitz Comments (407) Excellent!

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17 Oct, 01:31 PMReplyLike1 bartpr Comments (1864) i am not in the market in any big way, two stocks. my main concern now is that unborrowed reserves being used to fuel speculation. massive unborrowed reserves have to be disapated before its all over for one. events can happen to change investor behavior, like some kind of crisis, with real consequences like liquidity going south, even with high reserves. its too much for this 73 year old to endure. i wonder how many of todays buyers have forgotten 2000 and 07. i sure have not, being a former buy and hold guy. lastly, i did not realize the extent of divergence of the market with the rest of these trends. thanks for your info. it is invaluable. 17 Oct, 01:34 PMReplyLike4
mobyss Comments (1326) "i wonder how many of todays buyers have forgotten 2000 and 07." Wall Street = 99.9% Main Street that was around for 2000 and 2007 = 90% 17 Oct, 03:20 PMReplyLike2
mickey99 Comments (167) Agree on all points. Right now, we there is little to prevent the market from rising, though. 17 Oct, 04:45 PMReplyLike1
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Publish GLOBAL MACRO WITH ETNs ETNs Today 3 Mths 1 Yr YTD IVOP 0% 0.7% 5.2% 6.9% XXV 0% 0.3% 1.5% 1.8% VXX -1.5% -24.9% -63.0% -65.1% VXZ -1.9% -9.4% -40.2% -38.7% XVZ -0.8% -8.4% -24.7% -21.6% DTUL 0% 3.4% 2.5% 2.7% DTYL -0.5% 4.6% -7.9% -6.6% DLBL -1.4% -0.9% -12.6% -12.2% BWV 0.1% 4.5% 10.2% 10.9% Alpha-Rich Ideas
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Stocks And QE: All Things Must Pass [SPDR Gold Trust (ETF), SPDR S&P 500 ETF

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Stocks And QE: All Things Must Pass

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wolfosc Comments (35)

Awesome. Thank you. 17 Oct, 11:18 AMReplyLike2

Mitch Zeitz Comments (407) Excellent!

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