QE Insanity and Liquidity Illusions

November 16, 2013

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QE is a “Feast for Wall Street”.

QE is very clearly and directly correlated with the rise of US equities.

QE impact on economic growth is minimal at best.

Headline economic data has become increasingly unreliable.

The disconnect between financial markets and the real economy continues to expand.

Liquidity illusion. The market and economic signals that people are currently seeing may not reflect underlying reality. The risk of making poor decisions based on a distorted market and economy are very high. This can result in a misallocation of resources on a massive scale.

Economic policy, as stated, has not really worked for 5 years, but Janet Yellen recommends more of the same.

An investment strategy for the times needs analysis and resolve to build and execute.

1. QE is “a feast for Wall Street”. This weeks Wall Street Journal article “Confessions of a Quantitive Easer” exposes the underlying reality of QE. It contains the incredible sentence “We were working feverishly to preserve the impression that the Fed knew what it was doing.”



Just in the last year through to the end of Q2 2013, total derivatives have increased by 11.5 Trillion, at reporting banks, on an increase of just 0.5 Trillion in deposits. So derivatives grew by over 21 times new deposits and 10 times greater than the Fed’s own balance sheet.

Profits from derivatives grew around 3.5 times over the same period. Trading revenues to net operating revenues grew from 11.3% to 26.5%. All figures from the FDIC reports.

Banks involvement in the markets has exploded over the year as they have become increasingly dominant participants. Remarkable profits have followed.

2. QE is very clearly and directly correlated with the rise in US equities. This article completely debunks a Mckinsey Report that argues otherwise:


“So, thanks to the US Treasury, we know that between January 2009 and April 2013, on days in which the Fed POMO was more than $5 billion, the stock market rose a total of 570 points, on days in which the POMO was less than $5 billion, the cumulative stock market gain was “only” 141 points, and when there was no POMO, the S&P gained… -51 points.”

Remarkable daily and long term correlation, but why is this really a good idea?

3. QE impact on economic growth is minimal at best.

Here is the record of 5 of the biggest central banks. While their assets have grown substantially in recent years there has been little change or correlation with GDP.


Does this policy even work theoretically? What does the manager of the world’s biggest hedge fund think?

What does Jim Rogers think?


4. Headline economic data has become increasingly unreliable. Although proper analysis of the details is still very revealing. There are much better sources that will inform investors far more accurately.


In general, though, it now takes hard work and analysis to reach a valid assessment.

5. The disconnect between the financials markets and the real economy continues to expand.


This is the amazing disconnect we are seeing in European Equities between equity prices and earnings estimates.


Similar comparisons can be made for US equities.


6. Liquidity Illusion. The key issue is whether the markets represent durable wealth creation that is leading to a sustainable and balanced economy, which is what policy makers would have you believe. The alternative is that QE is creating a massive temporary distortion between equities and their underlying earnings. Are the equity market rallies really a downpayment on the future growth of earnings?

If not then Equities are increasingly reflecting a liquidity illusion and creating a valuation air pocket, and will at some stage have to converge back down to a more normal relationship with earnings levels. Furthermore, the signals that people are currently seeing may not be genuine economic signals. The risk of making poor decisions based on a distorted market and economy are also very high. This can result in a misallocation of resources on a massive scale.

In the end is it even a question which of these two scenarios we are currently experiencing? Do you really believe that all economic ills can be resolved simply by printing money and buying bonds? When was the last time in history that this actually worked? What is the evidence that after 5 years this policy is really solving our economic problems?

We all need to take great care in analyzing the markets and the economy at a time of record levels of distortion.

7. Economic policy has not really worked for 5 years. Why will it now? 5 years after the 2008 crash with relentless extreme measures taken by policy makers Janet Yellen makes it clear in this weeks testimony that the Federal Reserve is still far away from producing a strongly growing economy. The solution is even more of the same?


This is one of the most confusing and dangerous investment periods I have ever experienced. Investors need to be highly vigilant and careful at this stage. There are solutions but significant analysis and resolve is needed to build and execute a strategy that will work well through this period.


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