Stocks faltered during QE1 and recovered. Stocks also tumbled during QE2 and rallied back to new recovery highs. From its September high the S&P 500 has already lost 100 points, will QE3 bail out the stock market again?
QE3 looks like the Fed’s biggest boomerang yet. Bernanke announced QE3 on September 13. The S&P closed at 1,460 on this faithful day and recorded a new multi-year recovery high the very next day (1,474.51). Since then the S&P 500 is down 6%, the Nasdaq-100 nearly 10%, and Apple about 23%.
Can QE3 bail out stocks once again?
Based on the QE track record the answer is a plain and simple: Yes.
However, this may not be the time to take a plain vanilla approach. QE3 is the same animal as QE2, but a different breed and even QE2 had some serious genetic flaws that showed up on stock charts as big gashes.
QE2 vs. QE3 – Same Animal, Different Breed
Back in November 2010, I wrote an article on the correlation between the Fed’s Permanent Open Market Purchases (POMO, also known as QE2) and the S&P 500.
Specific transactions, such as coupon purchases of $3.5 billion or larger (back then the Fed was buying Treasuries), resulted in positive S&P performance 89% of the time (when there were no POMO buys, the S&P was up 58% of the time).
Via QE2 the Federal Reserve bought an average of $75 billion worth of Treasuries a month. Via QE3 the Federal Reserve is buying $40 billion of mortgage-backed securities (MBS) per month.
In Addition, throughout November, the Federal Reserve will purchase $47 billion worth of long-term Treasuries (maturities from 2018 – 2042) and sell $37 billion worth of shorter-term Treasuries (maturities from 2013 – 2015).
The net amount of securities purchased by the Federal Reserve (in November and December) will be $50 billion, compared to about $75 billion during QE2 (I’m not sure if the Fed is still reinvesting maturing Treasuries and if it will extend Operation Twist, scheduled to expire at the end of the year).
QE2 – Not Everything That Shines is Gold
The thought of QE2 triggers images of relentlessly rising stock indexes. Sandwiched in between those “market on steroids” segments, however, were nasty selloffs. One in March 2011 (Japan earthquake) and one in May 2011 (the May 2010 and July 2011 meltdowns happened right after QE1 and QE2 ended).
From the beginning to the end of QE2 the S&P gained only 11%. The chart below shows exactly when the various QE’s started, when they ended, how much stocks gained, and the selloffs in between.
QE doesn’t guarantee higher prices, but thus far in this QE bull market stocks have always been able to recover from any decline and move on to bigger and better highs. Will this be the case again?
The S&P 500 and Dow Jones didn’t show any major breadth divergences at their September highs and there are some giant open chart gaps, which suggests that prices will indeed end up recovering some of the recent losses.
So the odds for an eventual year-end rally are good (not sure if it will reach new recovery highs), but we haven’t seen panic selling or bullish price/RSI divergences that would point to any sort of more permanent bottom (we may say a daily price/RSI divergence at today’s close).
At the Profit Radar Report we will simply continue to adjust the stop-loss level for our short positions. This virtually guarantees a profitable trade and exposes us to all the profit potential on the short side. We will take profits once indictors tell us a bottom is near.
The Profit Radar Report monitors money flow, seasonality, sentiment, technicals and other developments to identify low risk and high probability trades and investment opportunities for subscribers.