Be Afraid

by: Tim Price

Excerpted From Today's PFP Wealth Management Letter:

One disadvantage of asset purchases relative to conventional monetary policy is that we have much less experience in judging the economic effects of this policy instrument, which makes it challenging to determine the appropriate quantity and pace of purchases and to communicate this policy response to the public.

- Federal Reserve chairman Ben Bernanke, referring to quantitative easing

Or to put it another way: we don’t know if it will work, and we don’t know how to spin it. These are dismal days. Having exhausted conventional monetary policy, the Federal Reserve is busily exercising its two remaining options: clutching at straws, and pushing on strings. The ultimate outcome from QE2 remains to be seen. In the short term, though, stock markets and indeed most other financial assets have reacted in classic Pavlovian fashion: ring the dinner bell announcing fresh liquidity, and they will rally in response.

This should give equity investors pause. Assuming some correlation between economic growth and market return, the announcement of general desperation on the part of the central bank does not equate to a favorable fundamental backdrop for investors. Rather, it merely perpetuates a general euphoria sponsored by liquidity provision and nothing else.

The advice for equity market investors must remain: enjoy the party, but dance near the door.

See full letter (pdf)