What does $85 billion a month buy you in this market? Plenty!
That’s what Fed Chairman Ben Bernanke sees, as the Dow Jones industrial average and S&P 500 both reached all-time highs on Friday.
But the Fed’s $3.3 trillion bond-buying spree to stimulate the US economy, which is the driver of the equity run-up, cannot last forever, Fed officials said Friday, and that has market pros wary.
“Each round is having less impact, despite the higher dosages of bond buying,” said Jeffrey Sherman, a portfolio manager at DoubleLine Capital.
“The Fed originally started out with the Troubled Asset Relief Program, committing $700 billion. Now it’s committing more than $1 trillion a year. It’s like giving a higher and higher dose each time to a drug addict and . . . Bernanke is the dealer here for this cocaine habit.”
In fact, the Federal Reserve’s actions had the biggest impact at the start of its easing programs, from late 2008 to March 2010. That first intervention lasted 17 months and saw the S&P gain 47 percent.
The next dose, from November 2010 to June 2011, was a more subdued affair; through a shorter span of eight months, the S&P 500 gained 10 percent.
The most recent interventions, including Operation Twist, generated gains of 35 percent over 21 months.
Dean Erickson, founder and CEO of money manager Bionic Capital, recalls an analogy that made the rounds of the banks: “Quantitative easing is like when you’re eating a great dessert,” he said. “The first bite is so delicious, it can rock your world, the 10th bite is OK, but the 18th bite makes you sick. The law of diminishing returns holds for dessert and QE.”
Sherman says the first round worked best because markets had come off their lows — the Dow was then around 7,000.
The music will eventually stop, he predicts.
“If the Fed perceives things are going well, maybe they’ll take their foot off the gas pedal a bit. It could have ramifications.”
Added Francis Scotland, director of global macro research at Brandywine: “The really smart people are asking what are the long-term unintended consequences of this. What comes to mind are the blurring of monetary and fiscal policy, asset-price distortions and inflation. That is how it could end badly.”
Sherman sees plenty of warning signs. These include a low-growth economy with declining incomes and a huge number of unemployed people not counted in the official statistics. Then there is the overhang from the national debt, at about $16.7 trillion.
And if stocks really reflect an economy on the mend, it’s not showing up in a strong commodities market.
But that hasn’t stopped some pundits from popping the champagne. The Dow briskly closed Tuesday above 15,000, a 14 percent gain for the year — just three months after it roared past 14,000 for the first time since 2007. The broader S&P 500 and rival Nasdaq were up 13 percent.
“Is it an artificial, phony rally?” asked Sherman. “Absolutely.”
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