Right or wrong? The QE bull market will last as long as the Federal Reserve keeps QE going. A majority of investors say ‘Yes,’ but a curiously sophisticated experiment and powerful data suggest a surprise outcome.
In 2004 Daniel Simons of the University of Illinois and Christopher Chabris of Harvard University conducted a fascinating experiment.
If you want to be part of the experience take a minute (it literally only takes a minute) and watch this video before you continue reading.
To get the full effect, watch the video first and don’t read ahead.
If you don’t want to watch the video, here’s a quick summary:
Truth in Simplicity
The experiment is quite simple. There are two groups of three people each. One group is wearing black shirts, the other group white shirts.
The three people wearing black shirts are passing one ball to fellow black shirts; the ones wearing white shirts are doing the same. So there are six people, passing two balls.
The assignment is to watch how many times the players wearing white, pass the basketball.
It’s a simple assignment that requires some concentration and a clear mind.
The answer: The white shirts pass the ball 15 times.
But wait, there’s more. Many viewers get the number of passes right, but completely overlook a woman dressed in a gorilla suit. The gorilla walks slowly across the scene, stops to face the camera, and thumps her chest.
Half of the people watching the video did not see the gorilla. After watching the video for a second time, some of them refused to accept that they were looking at the same tape and thought it was a different version of the video.
“That’s nice, but what’s your point Simon?” Good question.
The Invisible 800-Pound Gorilla
The experiment was supposed to illustrate the phenomenon of unintentional blindness, also known as perceptual blindness. This condition prevents people from perceiving things that are in plain sight (such as the bear markets of 2000 and 2008).
Much of the media has zeroed in on one singular cause for higher or lower prices. Sample headlines below:
Reuters: Wall Street climbs as GDP data eases fear of Fed pullback
Reuters: Brightening jobs picture may draw Fed closer to tapering
Reuters: Wall Street slips amid Fed caution
The media is busy ‘counting passes,’ or watching Bernanke’s every word and interpret even the slightest variation of terminology.
The Fed’s action is the only thing that matters, but amidst ‘counting passes,’ many overlook the gorilla.
It’s believed that a rising QE liquidity tide lifts all boats. This was impressively demonstrated in 2010 and 2011 when various asset classes and commodities reached all-time highs. It only conditionally applies to 2012 and 2013 though.
In 2011 gold and silver rallied to nominal all-time highs. Why?
- The Fed pumped money into the system (aka banks) and all that excess liquidity had to be invested somewhere, anywhere, including precious metals.
- Fear of inflation. Gold is known is the only real currency and inflation hedge. Silver rode gold’s coattail and became known as the poor-man’s gold. From 2008 – 2011 gold prices nearly tripled and silver went from $8.50 to $50/ounce.
Since its 2011 high, the SPDR Gold Shares ETF (NYSEArca: GLD) has fallen as much as 38.29% and the iShares Silver Trust (NYSEArca: SLV) was down as much as 63.41%.
This doesn’t make (conventional) sense or does it. QE or the fear of inflation didn’t stop in 2011. In fact, QE (and the associated risk of inflation) is stronger than ever. Based on the above rationale, the gold and silvers meltdown is inconceivable and unexplainable.
The QE ‘Crown Jewel’
Initially QE was limited to government bonds or Treasury bonds. In other words, the Federal Reserve would buy Treasuries of various durations from banks and primary dealers with freshly printed money.
The effect was intentionally twofold:
- The Fed would pay top dollars to keep Treasury prices artificially inflated and interest rates low.
- The banks would have extra money to ‘play’ with and drive up asset prices, a process Mr. Bernanke dubbed the ‘wealth effect.’
With that thought in mind, take a look at the iShares 20+ year Treasury ETF (NYSEArca: TLT) chart above.
From the May peak to June trough TLT tumbled 14.56%, more than twice as much as the S&P 500 (7.52%).
The lessons are simple:
- QE doesn’t always work and can misfire badly.
- We don’t see every gorilla (or looming bear).
All this doesn’t mean that the market will crash tomorrow. In fact, the stock market doesn’t exhibit the tell tale signs of a major top right now and higher highs seem likely.
Unintentional blindness is real and often magnified by the herding effect. The investing crowd (or herd) is convinced that stocks will go up as long as the Fed feeds Wall Street.
The above charts suggests that we shouldn’t follow this assumption blindly.