Bearish investors and market watchers have had a tough time dealing with monetary policy from the Federal Reserve in recent years. No matter how persuasive their views on corporate earnings, profit margins valuations and global economic health, all it takes to send stocks higher it seems is a bold move from the Fed.
Ed Yardeni, chief investment strategist at Yardeni Research, reminds us of the powerful effects of Fed policy. After the first round of quantitative easing – a policy that involves printing money to buy bonds – the S&P 500 rose 36.4 per cent. After the second round of QE, it rose 24.1 per cent. And so far it has risen about 4 per cent since Ben Bernanke, the chairman of the Federal Reserve, mentioned the need for a third round of easing in a speech at the end of August.
"The central banks have certainly succeeded in turning investors into QE junkies," Mr. Yardeni said in a note.
Sure, you can point out that the boost from Fed policy appears to be getting smaller with each round of stimulus – but up is still up, and the gains have recently sent the S&P 500 to its highest levels since the end of 2007, though the index was down slightly on Monday.
For someone like John Hussman, a bearish investor who shares his thoughts on the market through a weekly letter to his clients, these gains are painful. He has been arguing for some time that the risk-to-reward profile for U.S. stocks is very unattractive, making the S&P 500 prone to a sizeable drop. And while Fed policy might be able to provide a short-term boost to stocks, it cannot give the market an extreme makeover.
But is such thinking powerless next to quantitative easing? Mr. Hussman believes that with the Fed's latest move to buy mortgage bonds without an end-date – making the stimulus open-ended – the central bank has essentially gone "all-in." In other words, it has used up its key tools, giving investors little to strive for from now on.
The open-end move, he argues, removes the "constant anticipation that the Fed would draw the last arrow from its quiver to kill off every prudent element of our economic system. As Bernanke noted at his press conference, the Fed has been down to two main tools given that interest rates are effectively zero: 'balance sheet action, and of course, we can restructure those – change those in various ways. The other type of tool is communication tools. And we could – we continue to work on how to best communicate with the public.'"
"So the Fed has now left itself with nothing but talk," Mr Hussman said.