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Monday, May 27, 2013

On Dow on Titans of Finance, QE and share prices

Mark Dow writes

So if the banks and shadow banks can just as easily repo their Treasury and mortgage holdings to finance lending, and there is no link between base money and credit creation, why is the Fed doing QE in the first place?
By keeping rates low well out on the yield curve and providing comfort that the Fed will be there to fight the risk of recession and deflation, it creates an environment that enables, over time, a normalization of risk taking in the real economy. Our revealed belief is that the Fed can chop these nastier outcomes off the left-hand side of the distribution. As a result we start feeling better about getting our money back out of the mattress and putting it back to work.

This is not a semantic point. I can hear traders saying, “yeah, whatever, who cares, don’t fight the Fed, just buy.” But this concept has huge implications for the phase where the Fed decides to remove the training wheels. If the Fed money is not directly propping up the stock market and the economy underneath has been healing, the much talked about wedge between “Fed-induced valuations” and “the fundamentals” is likely considerably smaller than the consensus seems to think. It’s less “artificial.” In short, what all this means is the day the Fed lets up off the gas might give us a blip, or maybe that long-awaited correction, but ultimately the Policy Bears will end up getting crushed, again.

I comment

You assume that QE must be driving share prices up somehow.  You explain how it isn't as simple as many think (I didn't know about them).  But what if this isn't happening at all ?

So why is the Fed doing QE.  Well we are in uncharted terrritory.  I have great respect for Ben Bernanke, but that doesn't mean that he can tell if QE works without trying it. That woul require not just being a genius (I'm sure he is) but having rational expectations and he is human.  Also one uses the tools one has.  Even if QE doesn't work very well, it's all they have left at the zero lower bound.  It's better to light one small candle than curse against the darkness.  It is also better to buy $600,000,000,000 of Treasury notes (QE II) than curse against the darkness.

In fact, the post as a whole seems to me to suggest that QE has caused lower stock prices.  Convincing titans of finance that something is driving prices above fundamentals should drive prices down as arithmetic says that this belief causes them to estimate a lower fundamental value.  And they have titanic risk bearing capacity.  The fear of a correction when the Fed takes the training wheels off should cause lower prices. What if that is the main effect of QE on share prices.

Correlation is not causation. Especially the argument thta these things happened in the same quarter so one caused the other is very unconvincing.  I agree that the standard event study depends on the false EMH, but the modest announcement effect of QE III and wrong sign daily shift of QEIV should make you worry no ?

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