03/16/11   Fed: Don’t Bet on QE3

Editor’s Corner

Investor Heat Map: 3/16/11Fed: Don’t Bet on QE3 

Ron Rowland

One of the first rules of statistics is “Correlation does not equal causation.”  The mere fact that two events happen simultaneously does not mean that one caused the other.  The Japanese catastrophe is obviously bad news, but is it really driving down stock prices in New York?  In some cases, yes.  Other factors are at work as well.

Tuesday’s Federal Reserve policy meeting was, in its own way, as surprising as the earthquake across the sea.  Traders have been intensely probing for clues on whether QE2 will be extended, expanded, or ended early.  This week’s Fed statement contained strong hints that further stimulus is unlikely, removing previous text that the economic recovery is “disappointingly slow” and that “tight credit” is cutting into consumer spending.  The statement also dropped references to “modest income growth” and “lower housing wealth.”
Of course the Fed hedged itself with plenty of cautionary language, too.  The icing on the cake is that the vote on this statement was unanimous.  This suggests Charles Plosser and Richard Fisher, the two inflation hawks on the committee who have dissented before, are now reasonably satisfied with the Fed’s policy direction.
The Fed may well be wrong once again and can always change its mind.  The situation in the Middle East and ongoing debt crisis in Europe are still big question marks.  For the moment, however, a liquidity-driven bull market is mainly concerned with the prospect of no more new liquidity.
Whether they are the cause, or just the catalysts, for the global sell-off, the ongoing events in Japan will likely have a dramatic impact on various markets for months and years to come.  The nuclear industry has been dealt a devastating blow.  Plagued for decades by public safety concerns, the industry has been enjoying a resurgence the past few years thanks to $100 oil prices and fading memories of Chernobyl and Three Mile Island.  Those concerns are once again coming to the forefront, bringing with them uncertainty about the future of nuclear energy.  Japanese equities suffered huge declines this past week, but nuclear energy funds have been hit even harder

One of the first rules of statistics is “Correlation does not equal causation.”  The mere fact that two events happen simultaneously does not mean that one caused the other.  The Japanese catastrophe is obviously bad news, but is it really driving down stock prices in New York?  In some cases, yes.  Other factors are at work as well.

Tuesday’s Federal Reserve policy meeting was, in its own way, as surprising as the earthquake across the sea.  Traders have been intensely probing for clues on whether QE2 will be extended, expanded, or ended early.  This week’s Fed statement contained strong hints that further stimulus is unlikely, removing previous text that the economic recovery is “disappointingly slow” and that “tight credit” is cutting into consumer spending.  The statement also dropped references to “modest income growth” and “lower housing wealth.”

Of course the Fed hedged itself with plenty of cautionary language, too.  The icing on the cake is that the vote on this statement was unanimous.  This suggests Charles Plosser and Richard Fisher, the two inflation hawks on the committee who have dissented before, are now reasonably satisfied with the Fed’s policy direction.

The Fed may well be wrong once again and can always change its mind.  The situation in the Middle East and ongoing debt crisis in Europe are still big question marks.  For the moment, however, a liquidity-driven bull market is mainly concerned with the prospect of no more new liquidity.

Whether they are the cause, or just the catalysts, for the global sell-off, the ongoing events in Japan will likely have a dramatic impact on various markets for months and years to come.  The nuclear industry has been dealt a devastating blow.  Plagued for decades by public safety concerns, the industry has been enjoying a resurgence the past few years thanks to $100 oil prices and fading memories of Chernobyl and Three Mile Island.  Those concerns are once again coming to the forefront, bringing with them uncertainty about the future of nuclear energy.  Japanese equities suffered huge declines this past week, but nuclear energy funds have been hit even harder.

Sectors

We’ve watched sector rotation graphically illustrated in these musings the last few weeks.  Energy is still #1 by a wide margin, though it took a hit along with everything else recently.  More interesting is the simultaneous rise of Health Care and decline of Technology.  Tech and its cousin Telecom now share the basement and are both trending downward.  Former bottom-dweller Health Care is now in the top four.  Other defensive sectors also improved, though increased scrutiny of the nuclear industry will be unhelpful for some members of the Utilities sector.

Styles

The Style rankings are even more compressed this week than last.  As is expected in a broad sell-off, all the categories lost momentum, but as yet none have flipped into a downtrend.  Some will almost certainly do so, barring a dramatic rally in the next few days.  Micro Cap took the biggest fall, declining from third to last place.

International

Positive momentum was sucked right out of the Global rankings since our last report.  Japan dropped into last place as the Nikkei plunged Monday and Tuesday.  While one can make a case that Japan is oversold, the full extent of nuclear problems and economic impact of earthquake and tsunami damage is still unknown.  Canada held on to its first-place ranking but lost most of its bullish momentum.  Dependence on energy and materials ceased being helpful when resource prices tumbled.  The U.S. stayed in second place as the dollar stabilized a bit.  China continued to gain relative strength, moving up to the #3 spot this week.


Note:

The charts above depict both the relative strength and absolute strength of various market sectors, styles, and geographic locations on an intermediate-term basis. Each grouping is sorted (top to bottom) by relative strength. The magnitude of the displayed RSM value is a measure of absolute strength, which is our proprietary method of measuring and reporting the intermediate-term strength as an annualized value.


“Information received since the Federal Open Market Committee met in January suggests that the economic recovery is on a firmer footing, and overall conditions in the labor market appear to be improving gradually.”

FOMC Statement, March 2011


DISCLOSURE

© 2011 AllStarInvestor.com All Rights Reserved. Protected by copyright laws of the United States and international treaties. Nothing in this e-mail should be considered personalized investment advice. Although our employees may answer your general customer service questions, they are not licensed under securities laws to address your particular investment situation. No communication by our employees to you should be deemed as personalized investment advice. Any investments recommended in this letter should be made only after consulting with your investment advisor and only after reviewing the prospectus or financial statements of the company. All Star Investor employees, its affiliates, and clients may hold positions in the recommended securities.

Distribution is encouraged. Please do not alter content.