There is still all this hope about QE3. I think it is mostly stock market junkies, but they are very myopic individuals. I am not going to pull punches with this one, because the hope and disappointment of QE has replaced the ups and downs of the Euro. There is not a clear understanding of what QE3 is, what it does, or its overall purpose.
I have discussed this before here and here. Read them because I am not going to be repeating myself. Let us talk about the consequences of QE more. Flood the market with all this cash when bonds yield almost a negative return and you risk all of it being shoveled into equities. I know that to most readers a pop in equities seems great. Do not be so short-sighted. Yes it might help those of us that trade short-term, until you get caught on one bad day. The potential consequences of QE3 would be bad for the buy and hold investor, the position trader, and the short-term trader with no luck. Options traders might do a little bit better just because they tend to risk less, but they would lose what they invest and not have the chance to see it bounce back. I’ll discuss the scenario after the jump.
Shoveling money into equities will look good in your portfolio for a while, but you’ll start getting inflated stocks. For those of you that like to hold onto your investments, think about it this way. You look at P/E to determine if a stock is overvalued or undervalued. You take into consideration things like whether it is a growth stock or now. Well if money starts flowing into equities you will see these P/E ratios increase. If the economy does not improve, then the companies will not be posting better results but their stock prices will continue to increase. Does that sound like another bubble to you?
Everyone gets hurt in bubbles for the most part. Even those short-term quick traders can get burned if they aren’t lucky. Eventually stock prices will suffer a severe correction as people realized that the companies they own are not actually worth the current price. That would be awful, because this can happen even as the economy starts to improve. Not only will you lose your gains, but you know that retail investors will jump in too late and buy at the high. It would be horrible to see two severe drops in so short a time.
The focus should be on improving the economy. There are lots of ways to spur demand. Reducing the income gap is not just lefty talk it is important to have a viable economy. QE3 does not solve anything. And if it is just the best thing they can do consider Congress is useless, then they should do nothing. The threat of QE3 rallies the market, but not as much as actual money flowing would do. Let the algorithmic traders and wall street tycoons chase their mystical QE. For the sake of the rest of us, let us hope that equities remain more fairly priced considering the economy.
On a long-term time scale I like that because I can buy here and participate in the economic growth once it begins. Don’t count the world economy out just yet. And don’t count the US out. On a shorter time scale, when the turn around for the economy does start there should be some great opportunities to buy calls. Right now it is horrible for options because things are kind of flat. QE3 does not benefit society as a whole, so why desire it?
And no I am not worried about inflation. That is not a reason not to do QE. The Fed has tons of ways to fight inflation. It is deflation that is the problem. And inflation has not materialized yet. When it does interest rates will go up. You can buy bonds or keep money in CDs. They can raise interest rates up to 10% to suck the supply out of the economy if they need to. So do not worry about inflation like all the Cassandras. Correction, do not worry as much. Most often inflation does not just happen. You do not go from 1-2% to 50% in a quarter. You see it coming.