What’s good is bad; what’s bad is good. There have been a few times in my investing career when this paradigm has existed, and we may be heading into this topsy-turvey market environment once again.
The source of this strange state of existence is as usual the Federal Reserve, or more accurately investor behavior in reaction to what the Fed might be doing.
As we’ve discussed, the Fed is currently conducting an aggressive form of monetary stimulus, which it benignly calls QE3. This QE3 program involves the creation and injection into the financial system of $85 billion newly created dollars each month.
This unconventional program is aimed at making sure our economy remains awash in liquidity in order to avoid another credit type crisis, the direct side effect of which is the prices of most financial assets as well as many hard assets (such as real estate) are rising creating what is called the “wealth effect”.
The wealth effect theory says if consumers and investors experience rising values in their investment statements and home prices they will be more likely to spend money and invest more, thereby driving consumption and investment higher, which then leads to stronger economic growth.
The strategy might work, it might not. Two concerns are certain, first no one really knows what the potential impact of this intense stimulus program might be over the intermediate term, and second, sooner or later it has to end. It’s the latter concern that has markets in a jittery mood, because investors really like QE3, in fact some might say markets in general are a bit addicted to it at this point.
So hence the upside down reactions to economic news. Previously the Fed has said it would continue this type of aggressive stimulus until the unemployment rate reaches 6.5 percent. At the end of April this rate was at 7.5 percent, and in order to get to 6.5 percent our economy would have to create about another 1.5 million jobs.
Friday morning the government will release the number of jobs our economy created in May, expected to be around 150,000. So simple math says going to be a little while before the Fed pulls on the QE3 reigns. It will be interesting, however, to see how markets react if this number comes in substantially higher or lower than expected, and the reaction might be the opposite of logical.
Logically more jobs being created is good; logically interest rates probably should be a little higher than they are today. Sustainable economic growth not artificially supported by the Fed’s programs will be good for investors.
Like the road to curing any addiction however, enduring the journey while markets are weaned off the Fed’s easy money policies is bound to be a rocky for both stock and bond market investors alike.