Outside the Box

What If the Fed Has It All Wrong?

September 24, 2012

As long-time readers know, I get a large volume of research sent my way. I can't get to all of it every week, but I really do try. And today's Outside the Box, from a new (to me) source, hooked me from the first few paragraphs.

Correlation is not causation, as we all know. That brings us to the Fed, where many market observers are seeing causation when there might be other reasons for stock market movements. What if the victory lap Bernanke has taken due to stock market results is perhaps a little too early or out of place entirely? And what might that potentially say about future market performance and correlations?

Denis Ouellet wrote today's Outside the Box and graciously gave me permission to use it. I asked him a little about who he is. Turns out he lives in Montreal (but winters in Florida), is almost 60, and has retired after nearly 35 years in the investment business as an analyst and head of research for a brokerage company, an equity manager for various investment organizations (pension, mutual, and hedge funds], head of global equity investments at a major pension fund, and chairman of the equity investment committee of a major pension and mutual fund investment organization.  Like me, he travels around the world and has lots of kids (just 5 in his case). His blog is New$ to Use.

I leave on Wednesday for Atlanta and will eventually end up in New York on Sunday to start a 36-hour marathon of meetings and interviews, plus a speech or two. On Tuesday morning I am with Tom Keene on Bloomberg at 7-7:30 AM.

Your always paying attention to earnings analyst,

John Mauldin, Editor
Outside the Box

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What If the Fed Has It All Wrong?

This is the 4th major intervention from the Fed since 2009, each one apparently inflating asset prices without having a definitive impact on the economy other than, most importantly, preventing a lethal debt-deflation spiral.

The chart above is used extensively to illustrate the close relationship between QEs and equity prices. Hence investors' Pavlovian reaction to last week's FOMC…

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Discuss This


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Terri Champlin

Sep. 26, 2012, 12:54 p.m.

Denis Ouellet is great!  Thanks for passing him on.

Mike Fahey

Sep. 25, 2012, 4:54 p.m.

The whole idea that equity gains and liquidity infusions that correlate with it are not of benefit to Main Street could be easily fixed.  First the Fed should stop paying interest to banks for depositing funds and charge them some minimal fee instead, earning enough to pay for some of the QE expense, and there should be some medium term consequences on retained earnings in the form of taxation [3 year max pro rated each fiscal year to “encourage” investment] or help fund US debt reduction.  I’m pretty confident that the jobs situation improve fairly quickly compared to the incentivized conservative investment paradigm at present.

Michael Strong

Sep. 25, 2012, 3:35 p.m.

This is a fascinating analysis. So we have two very serious problems: huge debt which cannot be repaid and concentrations of wealth. Growth for many years has been financed by debt so reining in the mounting debt has led to unemployment and even greater concentrations of wealth. QE has not worked due to a misunderstanding of money supply which equals notes in circulation x velocity of money. QE increases notes in circulation but if anything slows down velocity. Inflating out of the debt could lead to massive inflation and serious unrest. As Ron Paul points out, since the Federal Reserve prints money for QE, it could simply transfer the debt it has bought to the Treasury, thus writing it off. But that is not the big issue. The big issue in the US at least is getting Americans back to work in order that they both pay off their debt AND buy goods and services provided by other Americans. Then at least a healthy economy will lead the way to sensible investment and then a healthy stock market. The banking system led us into this problem, enthusiastically supported by politicians, and right now they are keeping us there. The longer we fool around with QE, the harder it will be to address the fundamental health of the economy, that is to say I agree with Mr Rose’s summary.

Alex Pauza

Sep. 25, 2012, 12:15 p.m.

Or inflation is being significantly under-reported, and there is no undervaluation.