Global Macro Notes: Is “QE2” Priced In?

October 1, 2010

Steve Jobs and Ben Bernanke have something notable in common these days.

Apart from being graybeards, both have the weight of heavy expectations on their shoulders — and the fate of this severely extended market rally in their hands.

Apple (AAPL), a consumer tech company that makes expensive entertainment devices, is (hypothetically) on its way to being the number one market cap company in the world.

AAPL seems to hold court at the top of every “conviction buy” list in the land — a “no brainer” go-to name for fund managers to park incremental capital flows.

In result, AAPL has swelled to roughly 20% of the Nasdaq 100 (QQQQ) weighting. As far as speculative appetite is concerned, “as goes Apple, so goes the market.”

And as for Fed Chairman Bernanke? He is now seen as master of the tide that lifts all boats, i.e. the wielder of “QE2” (quantitative easing, the sequel).

Thanks to Wall Street’s drooling belief in the power of QE2, investors made it the best September in 70+ years for the stock market, pursuing risk assets like a Great Dane who has heard the word “bone.”

In addition to putting aggressive bids under a whole slew of speculative names, this new orientation has given fresh legs to the DGDF “dollar goes down forever” meme, with all other considerations, macroeconomic and otherwise, completely pushed aside.
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Growing troubles in the eurozone? Doesn’t matter. Troubling lack of traction in the real economy? Doesn’t matter. Growing threat of a housing double dip? Doesn’t matter. Consumer confidence hitting eight-month lows, boding ill for Christmas season? Doesn’t matter. Geopolitical wildcard implications of potential trade war? Doesn’t matter.

Then, too, there are reasons why, in the depths of the 2008 financial meltdown, US treasury bonds and the $USD skyrocketed while most everything else (perhaps excepting gold) went to hell. (Those reasons don’t matter either.)

For now — or the past few weeks at least — visions of QE2 have conquered all. So none of the above makes a difference.

Until, of course, the day when one of those concerns (or more than one) suddenly DO matter again.

One of the functions of the market, at least in theory, is to act as a discounting mechanism. The ups and downs of future cash flow streams — and future government actions — should be factored into prevailing prices as fundamental factors are widely dispersed.

This naturally leads to a question:

  • To what degree is the ongoing success of AAPL already priced in?
  • To what degree is the impact of QE2 already priced in?

To this trader’s mind, we have now stumbled across the most important similarity between Messieurs Jobs and Bernanke. Their future actions — and the presumed success of those actions — may have already been “priced in” by the market, leaving little room for disappointment.

At this point, the question may not be what a glorious future Apple holds. Instead the question may be, who is left to hear the AAPL story and act on it by committing substantial new funds — and to what degree AAPL could stumble if the high hurdle of lofty expectations is not met.

(As an aside, it seems the fate of every cult growth stock is to eventually be laid low by its followers — hopes flying higher and higher, until finally the share price that could do no wrong, subjected to increasingly messianic expectations, is turned into a blood sacrifice.)

Similarly, one could further argue that awareness of the “QE2 bid” is also now about as widely dispersed as it can get. When the market levitated in the face of horrible consumer confidence earlier this week, it was attributed to speculation that more ugliness just means more QE2 goodness down the road.

And what happens, pray tell, if the gravitational pull of the real economy overcomes the upward thrust of QE2 risk-asset juicing… or if Bernanke’s benevolent hand is stayed by weak signs of an economic pulse — not strong enough to bring great cheer, but enough to keep “full-throttle” QE2 at bay?

At the same time, the idea that QE2 can drive stock prices higher in perpetuity seems almost obnoxious in its pure unadulterated cynicism.

Even the Fed itself has more or less admitted that the purpose of QE was not so much to shore up the real economy as to

  1. save bank balance sheets in the aftermath of the ’09 meltdown, and
  2. create a perpetual bid for risk assets, in the hope that “animal spirits” would then drift into the real economy and help Main Street as a side benefit.

And so, now, we have reached the point where those who cheer asset inflation at any cost have demonstrated that they really, truly, could care less about monetary policy as relating to the actual fate of the real American economy (as opposed to the heavily manipulated and stimulated paper economy).

One might shrug and say that this is simply the nature of the game — and one would be correct in this — except for the fact that the paper economy and the real economy ARE still linked.

Extended periods of “decoupling” between “paper” and “real” are genuine and significant, but a complete untethering is something else entirely. The tether is long, and exceptionally stretched at times, but nonetheless it is still there.

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And so, at some point (perhaps not long in coming) Mr. Market may be forced to grudgingly recognize anew that, apart from lavishly saving the banks, not only did the first round of QE utterly fail the real economy, it may have actually made the plight of the average consumer worse, by destroying any safe path to savings and inviting a recessionary rise in the cost of living by way of escalating food and energy prices. (You know, the inputs that the CPI chooses to ignore.)

Getting back to Jobs and Bernanke: Growth story aside, to believe that AAPL can grow forever without a stumble is to believe, naively, that trees can grow to the sky. Alas and alack, they never do — though investors are happy to act as if they do, for extended periods of time.

And to believe that QE2 can keep the markets levitating forever-and-ever amen, in the face of a still-deteriorating real economy, and against a backdrop of forced consumer deleveraging that has barely just begun, is to ignore the impact of dire financial conditions on Main Street — and their inevitable blowback impact on Wall Street.

The surge in homeowner “short sales”… the dire state of the states… the persistent string of bank failures… the potential for massive job losses on Wall Street — eventually these factors will translate to lower corporate earnings, with the post-stimulus reckoning possibly appearing in the Q4 season to kick off October 7th.

(In a recent Forbes post, Sy Harding notes that, “In what has appeared to be a conundrum for several months, Wall Street has been raising its earnings estimates for the third quarter while at the same time economists and even the Federal Reserve have been bringing down their estimates of economic growth quite dramatically.”)

As a general rule, it’s not the horse so much as the odds on the wager that counts. Right now, the AAPL / QE2 wager looks fully priced indeed.


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2 Responses to Global Macro Notes: Is “QE2” Priced In?

  1. it's the pirate's life for me on October 2, 2010 at 11:58 am

    I just stumbled across your blog via your comment at Ritholz. I’m definitely adding you to my “daily required reading” list. Help me become more mercenary!

    • Jack Sparrow on October 2, 2010 at 3:52 pm

      Welcome aboard mate. Devils and black sheep and really bad eggs…

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