Today’s Fed decision to conduct QE3 – quantitative easing round 3, is completely pointless and dangerous. Pumping yet more liquidity into the economy, and more specifically buying bonds from banks to pump-up bank balance sheets while driving long rates down will not make banks loan money. Corporations and individuals are not sitting on the sidelines foregoing loans because they want to; banks are simply refusing to lend. No amount of additional liquidity is going to change their policies. I guarantee all of you that not a single bank had a meeting with its bankers today after the Fed’s decision to tell their bankers to start lending money. I seriously doubt that the vast majority of bankers even know what quantitative easing is! Banks are certainly not going to change their lending policies because the Fed wants them to lend more. Banks are not lending because they are not comfortable with the economy and do not want to risk defaults, period. They are making it extremely difficult for those with significant assets to refinance properties where the bank has strong collateral and the borrower has assets in addition to the property to pledge. There is no way banks are going to start lending to companies or individuals on unsecured loans and lines of credit, period. This position, again, has nothing to do with the level of interest rates or liquidity on bank balance sheets; it is a decision based solely on risk mitigation and this position will not change until or unless the economy gets a lot stronger.
Next year’s GDP growth does not look to improve significantly from 2012’s growth. In fact, I believe that achieving 2% next year will be optimistic. Many economists still believe the chance of another recession in the first half of 2013 is very likely (a double-dip recession). While I am not that pessimistic, I certainly do not believe 2013 is going to provide robust GDP growth in the U.S. Current valuations for U.S. equities are forecasting very significant growth in corporate profits for the coming several quarters, which is unrealistically optimistic as well, in my opinion. Couple this with the fact that the September/October time-frame is historically negative for stocks, and that we have elections coming up in November and you have the makings of a sizable correction possibility. One additional factor to consider is the tax situation, and the likelihood of the Bush tax cuts being allowed to expire. If Obama wins, he has already said he will allow the cuts to expire on everyone earning more than $250,000 per year, which includes small businesses. This amounts to a massive tax increase on the very individuals that move the markets. These individuals, with stock markets at the highest levels since 2007, have significant unrealized capital gains. If they believe, as I do, that tax rates will rise after this year, they will be highly motivated to realize those profits this tax year, which means they have to sell between now and the end of the year. If you add all this up, to me it appears highly probable that we will see a correction of magnitude very soon.
Given this analysis, I must recommend that investors take profits, raise cash, and wait for more attractive valuations.
(All investors should evaluate any recommendation in the context of their personal investment needs and risk tolerance. The advice of an expert should be sought before making any investment decisions.)