Stocks: It’s Beginning To Look A Lot Like QE

The stock market may finally be showing some signs of life more than two months after the U.S. Federal Reserve launched its latest balance sheet expanding monetary stimulus program (QE3) back in mid-September.  And this recent stock vitality is exhibiting itself through some daily trading patterns that became all too familiar during past QE programs over the last few years.

A closer look at the markets over the last few trading days since the Friday before Thanksgiving reveals some of the distinct market trading patterns that suggest it may be starting to get hopped up on QE.

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The first identifying characteristic of QE is a stock market that is trading lower in the futures market during the overnight hours only to recover back to the green by early trading in the U.S.  Such was the story on Wednesday, when futures were sharply lower overnight on word that European finance ministers had failed to reach an agreement to release the latest tranche of bailout funds to Greece.  But by the time the U.S. markets opened on Wednesday morning, stocks were incrementally higher.  The same could be said for Tuesday with the Moody’s credit downgrade of France, which had futures solidly lower heading into the overnight on Monday.  But once again, by the time the sun was rising on the east coast in the U.S., stocks were only barely lower and quickly moved into positive territory not long after the opening bell.

Another QE attribute is a market that either opens sharply lower or breaks sharply lower during the trading day only to rally back into positive territory by the close.  This was the trading pattern witnessed both the Friday before Thanksgiving as well as this past Tuesday.  In both cases, stocks rebounded to close higher after being down anywhere between -0.6% to -0.8% during the trading day.  While optimism over signs of a potential solution to the fiscal cliff debate in Washington and a few encouraging words from Fed Chairman Bernanke were cited as some of the possible reasons for why the markets rallied back on these days, the substance of these headlines were sufficiently soft to suggest that other forces were likely driving the sudden reversals on these days.

An additional characteristic of a QE driven market is one that is already trading higher through the day and then suddenly ramps to the upside in the final hour of trading.  Such was the pattern on the holiday shortened trading day on Friday.  Stocks got a strong start out of the gates on Monday but stalled after the first hour just above 1400 on the S&P 500.  Then suddenly with about 45 minutes remaining before the 1PM close, stocks exploded to the upside by tacking on another +0.5% by the end of the trading day.

Whether these recent QEish patterns continue in the coming days remains to be seen.  While the Fed’s balance sheet has shown some recent signals that it is finally starting to expand after having been essentially flat through early November, liquidity flows into the financial system may continue to be lumpy in the coming weeks due to the nature of the Fed’s MBS purchases.  But the longer the Fed’s QE program continues, the more this intermittent flow of liquidity is likely to build into a steady stream, particularly if the Fed adds outright Treasury purchases upon the conclusion of Operation Twist at the end of the year.  And as this liquidity flow builds, we are increasingly likely to see the stock market exhibit similar behavior like we have seen over the past week.

This post is for information purposes only. There are risks involved with investing including loss of principal. Gerring Wealth Management (GWM) makes no explicit or implicit guarantee with respect to performance or the outcome of any investment or projections made by GWM. There is no guarantee that the goals of the strategies discussed by GWM will be met.

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