Without Stimulus Market Can't Rally

 

The 'Helicopter Economics Investing Guide' is meant to help educate people on how to make profitable investing choices in the current economic environment. We have coined this term to describe the current monetary and fiscal policies of the U.S. government, which involve unprecedented money printing. This is the official blog of the New York Investing meetup.

Minutes from the last Fed's Open Market Committee meeting indicate the central bank is less likely to introduce more stimulus. While this should not have been surprising, stocks sold off on the news adding more evidence that the top has been put in.

The current market rally, indeed the entire market rally since mid-2009 has been produced primarily on liquidity provided by the Fed and other central banks. This liquidity not only allows the market to continue to rise, but it also props the market up. Without a continuing flow of liquidity, the market could easily hit an air pocket and fall apart and it can do so in a very short period of time.

The impact of what happens when just a hint that more liquidity won't be forthcoming can be seen by Wednesday's action. The Dow Jones was down 1.0% (125 points), the S&P 500 1.0% (14 points), Nasdaq 1.5% (45 points) and the small cap Russell 2000 1.7% (14 points). Commodities were hit even harder than stocks with gold dropping 3.0% or $51, silver down 4.2% or $1.33 and oil lower by $1.97 or 1.9%. Copper lost more than 3%. The major gold and silver mining ETF GDX was $ 2.05 lower or 4.2%. The junior version, the GDXJ, dropped an even dollar, also 4.2%.

While there seems to be a number of players in the market hoping for QE3, they are not likely to get their wish anytime soon. At this point it is almost impossible for the central that has been crying recovery for the past three years to justify such a move without seeming to be blatantly interfering with the ongoing presidential election. Moreover, even to an inflation-blind Fed, the risk of future rising prices is becoming increasingly difficult to ignore.

Traditionally, rallies last between six and seven months and this one is beginning its seventh month. The upside action on the indices has been decent even for an entire year. Rallies don't go to the sky however, but correct because too many people have bought and many of them have bought on margin. Once that point has been reached it takes very little to pull the market down and once the selling starts in earnest it becomes very difficult to stop. We may not be there yet, but we probably will be soon enough.


Disclosure: None

Daryl Montgomery
Author: "Inflation Investing - A Guide for the 2010s"
Organizer, New York Investing meetup
http://investing.meetup.com/21

This posting is editorial opinion. There is no intention to endorse the purchase or sale of any security.