Apparently I am not the only one who took issue with David Tepper’s comments that the market is now in a “win win” situation.  In today’s note, David Rosenberg says Tepper is not necessarily right.  Rosenberg believes Tepper is ignoring a potential third scenario (aside from his “win win” scenarios).  This of course, is the scenario I have repeatedly discussed – QE won’t work.  Rosenberg says:

“Too bad we weren’t invited as a guest on CNBC last Friday to engage in a friendly debate with this portfolio manager because he didn’t outline the third scenario, either because he doesn’t believe it or he just plain didn’t contemplate it or he’s simply not positioned for it.  That third scenario is that the economy weakens to such an extent that the Fed does indeed re-engage in QE, but that it does not work.  So the “E” goes down and the P/E multiple does not expand. Maybe it even contracts since it already has spent the past number of years reverting to the mean as are so many other market and macro variables (for example, the dividend yield, savings rate, homeownership rate and debt ratios). In this scenario, the stock market does not go up; it goes down.

Is it possible that QE2 won’t work?  The answer is yes.  How do we know?  Well, because the first round of QE didn’t work.  After all, if it had worked, the Fed obviously would not be openly contemplating the second round of balance sheet expansion.  If the objective was narrow in terms of bringing mortgage spreads in from sky-high levels, well, on that basis, it did help.”

I don’t entirely agree here.  QE1 worked because we were in a different environment.  The problem Bernanke was targeting in 2009 was one of bank balance sheets.  Bank balance sheets were loaded with toxic assets so replacing these assets with cash was most certainly beneficial.  It eliminated much of the risk associated with the banking system.  As Bernanke said at the time, the point of QE was to alleviate pressures in the credit markets.  As we can see from credit spreads he certainly succeeded in this regard.  But this is no longer the environment we are in.  As I said last week there are no bank balance sheets to fix.  There is no credit system to fix.  At this point, the only real fix is to generate real aggregate demand.  QE WILL NOT DO THIS.  This is clear from the first round of QE.  Japan’s long history with QE also confirms this.  Rosey elaborates:

“But it did not revive the housing market any more than the litany of other government programs, and the fact that the economy has slowed so sharply to near stall-speed in recent quarters is all anyone needs to know about the true success, or lack thereof, from the first round of QE. The Fed has cut its growth forecast twice in the past three months and has sliced its inflation forecast three times.  This was not was envisaged when the first round of QE was unveiled last year.  Normally, the pace of economic activity is accelerating to over a 5% annual rate in the second year of recovery, not slowing down to below 2% — especially with all the monetary, fiscal and bailout stimulus that is in the system.

Here’s the bottom line: if not for the stimulus and the inventory swing, the economy would have actually contracted this year.”

QE is not a “win win” situation. It is a desperate last ditch effort by a Fed that has no more tools left to utilize….

Source: Gluskin Sheff


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Cullen Roche

Mr. Roche is the Founder of Orcam Financial Group, LLC. Orcam is a financial services firm offering research, private advisory, institutional consulting and educational services.

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  • Speedy Gonazalez

    I fully agree with you, but I think the key issue is: How will QE impact the stock market?
    In my opinion positively, than one should buy high beta assets and wait for the FED to do its job (inflate asset prices)…
    The problem will after QE, by then one should short the market…

  • http://www.pragcap.com TPC

    That’s the whole problem though. QE does not inflate asset prices. It has a marginal impact on interest rates, but I would argue that we’ve reached a level of diminishing returns. The return you’re getting on your refi at this point is marginal at best.

    The Fed is trying to talk up inflation. They’re jawboning. Nothing more. QE does not result in inflation. There is no evidence that it does. In fact, I’d argue that a sound understanding of the actual operations proves that it does not.

  • making sense

    I was contemplating on the Fed Sept 21 “inflation target” statement and was wondering if the Fed is able to achieve it. I like this piece. If QEII fails, and the US becomes a 2nd Japan, the Fed can be ended as it will lose all its credibility and it will essentially become a joke.

  • http://www.pragcap.com TPC

    Better yet, we can merge the tsy and Fed and stop pretending that they aren’t the same entity. Then maybe we can hold the Fed accountable as a govt entity and end their cushy relationship with the big banks.

  • John Mc

    Wouldn’t surprise me if both Rosey and Tepper are correct. Everyone’s buying now in anticipation of QE. If the market goes up this week in response to weak economic news, we’ll know that’s the case. Then, when the “news” of QE hits the market, everyone realizes the impact is minimal, then we go down hard into 2011.

  • B Ferro

    I will go out on a limb and risk being villified in the comments section potentially, but I’m just gonna throw it out there that the sphere of the Fed and QE conversation needs to expand…

    In addition to considering the economic merits (or not) of QE, I think we are now in a situation where we should consider the ethical ones as well…

    A serious discussion of QE should invovle whether or not the unintended consequences of Fed intevention could now do far more harm than sitting by idly and doing nothing at all…

  • pigfarm

    You don’t need to block every shot, you just need to make the other guy think that you will. I believe those were the words of Kareem Abdul Jabbar. Given that our money is just an abstraction, albeit with very real consequences, I think that the point of QE 2 is to just “have it” to jawbone the market back up. Put another way the power of nuke as a tool of diplomacy is in it’s threat, not it’s use. Only in the case of QE 2, since our currency is not asset backed, it’s even better because we can just wave the wand fiat the capital into existence.

    I don’t know about you guys but I am in agreement with Tepper, understanding of course he could be selling into strength this week for all I know, but I’m looking to long a pullback anyway. Right now I’m tepidly on the short side though,and hoping we don’t get pre market gap ups like that of March/April.

  • http://www.derailedcapitalism.com Chris

    The equity markets continue to be removed from economic reality. The Federal Reserve, through POMO, can lower interest rates and prop the equity markets. However, the issue of diminishing returns comes in. The Fed will basically have to increase quantitative easing at an increasing rate to keep rates stable and the equity markets artificially high. Basically, another round of QE will help prop the markets for only a short period of time…

    There are many who argue deflation vs. hyperinflation, but economists and investors should be looking at ‘hyperdeflation’. As credit continues to contract, consumer goods (housing, cars, clothes) deflate, while necessities (food, energy, PM’s) continue to inflate. We are beginning to see signs of a US dollar heading into a tailspin, however, there is still significant deflation present in the economy which have kept prices stable in nominal terms.


  • http://www.pragcap.com TPC

    The problem is if you can’t even block the shot to begin with (the Fed is impotent). Eventually, the market will realize that QE does nothing. Then you get steam rolled as the opposition realizes you are a fraud.

  • harold hecuba

    TPC…a voice of reason. today we’ve seen calls of dow 36k from some stock almanac guy and calls for dow 1000 from prechter. this is hysterical. no one on this planet knows what will happen. (currency warfare is certainly heating up) prechter’s call may be obscene but this guy has spent an entire carreer studying cycles and he is completely dismissed. the belief that the fed can cure things is absolutely absurd. if they knew the solution they would have done it already. they have no clue and bernanke a student of the great depression has NEVER had a clue. the race to zero in currencies will continue.

  • quarks

    if the funds and the quants can provide fuel for a 2k point rally people will be back in the malls in droves emptying shelves allowing for momenta in the classic inventory cycle that will carry the economy for a few more years.

    It’s clear from listening to the nonesense coming out of the body politik that leaders in this country will again fail to manage the growth cycle any differently than previous growth cycles.

    The next time a politician speaks listen carefully. Typically they prounounce their understanding of the particular adverse condition that ailes our country; they follow this with a statement that they have a plan to repair the condition; then without outlining the method they intend to employ to repair the condition that ailes this country they make statements on the wonderful state the country will be in once they’ve repaired the condition.

    The citizens of this country are void of the ability to think critically.

  • billw

    You already have your answer about any real rally. The investors are voting with their money and have been moving out of equities for 20 weeks in a row. The ice in the market right now is extremely thin, and it will not take much to cause the next implosion. As we all know , there is a reason why October has been the time for a large number of crashes. It is the month when the bad news finally hits home for investors. There is no longer any place to hide.

  • pigfarm

    Well, and perhaps you disagree with me, but I think that if Helo Ben can buy us another quarter or 2 by just “threatening QE 2″, and maybe just 1 more quarter before actually pushing the button, if indeed it is necessary, which buys us another 3-4 quarters, then just maybe something fundamental can happen in the mean time that will build a better foundation for GDP growth.

    I’m not forecasting a rally up to 1500 next year but if Helo Ben can get us at least range bound for the next 2 years so that businesses aren’t scared of committing resources, then maybe we can innovate our way out of this mess.

    I’m just throwing this out there, but there’s a lot of stuff to be done in the energy space. My dad’s company will be putting the world’s first large scale coal gassification plant online in 2012, which would be a huge deal b/c it would set the stage not only for energy independence but also for making US a significant energy exporter.

    If Benny “comes clean” right now, he kills off projects like that coming to market. I think he is just buying time for reality to make it’s case for catching up with the “lie.”