The Probability Of QE3 Is Increasing Again

by: Paulo Santos

The Probability Of QE3 is Increasing Again. It's really quite simple, several economic data have been slowly turning south again. You saw it not just in Q1's GDP, saved by an unbelievably low deflator, but also on the weekly jobless claims numbers, as well as in several purchasing manager/regional indexes.

The jobless claims are already up to 388k, probably to be revised over 390k. This gets them closer to the 400k barrier where not only will the FED take notice, but once again you might start seeing non-farm payrolls approaching zero. This would surely result in a FED response, and hence, QE3.

Why is this happening now? I believe there are two large factors that can't be ignored. I had called attention to them previously:

  • The seasonal factors were misleadingly helping several different economic numbers, because of the way they were distorted by the 2008 economic implosion. I had brought this to attention in my article "Jobs Data Might Be A Statistical Mirage";
  • The unseasonably warm winter further helped several sectors and the consumer during the 2011-2012 winter. That effect is now going away, making for harder comparisons. I had written about this in my "The Weather Impact On Economic Data" article.

What is relevant here, though, is that it won't take much more deterioration in the economic numbers to have the FED act. So now we're torn between two effects:

  • In one hand, the economic deterioration is starting to become obvious, and that's a net negative for the markets, with some suffering already evident on the S&P (NYSEARCA:SPY) and Nasdaq (NASDAQ:QQQ), in the form of higher volatility. Granted, this was somewhat masked by Apple's (NASDAQ:AAPL) earnings, as well as wild speculation in names such as (NASDAQ:AMZN) - where earnings were lousy but beat deeply cut estimates. So here the economic developments clearly ask for lower markets;
  • But on the other hand, as soon as it becomes evident that the FED will print and buy, all the economic developments become irrelevant. If that happens, the market goes up, period. The effect is well explained in my article "How QE Moves the Markets".

But is it all bad?

No. There is one industry in particular, one that usually has a deep economic impact, where we can already talk of a bottom. That industry is housing. Housing has now stayed below a sustainable level for more than 3 years. Over that time, the inventory for sale has taken a huge hit (see chart below, source: Calculated Risk) and now although housing is local, in general terms we can say it's bottomed and will in all likelihood see higher levels of activity and perhaps even higher prices. Higher levels of activity will undoubtedly have a large economic impact due to the way housing pulls on many other industries, from furniture to appliances. It's not a coincidence that usually -- but not this time - housing is the industry that pulls the economy out of recessions.

Regarding the months of supply, keep in mind that this chart is somewhat misleading - it overstates the supply, due to the slow sales activity. Sales activity is bound to grow from depressed levels that don't represent household formation, and as such these months of supply will contract even further. Also, the tightness of the rental markets confirms the same conclusion.


The economic data are slowing to such an extent that the FED might be moved into action. Until that is clear, the market is under risk of weakness, once it becomes clear the FED will act, the market can't do any other thing than go up. Part of the weakness is explained by the fact that growth was both illusory (due to distorted seasonal factors) as well as helped by unseasonably warm weather during winter.

Not all is bad, housing as bottomed and, even in the absence of FED action should prove to be a positive factor for the economy. Usually this would lead me to recommend homebuilders (NYSEARCA:XHB). However, the homebuilders discounted so many housing recoveries before that they aren't cheap by any measure. Thus, they aren't really an investment as much as a speculation - and one I am not willing to take, myself.

Disclosure: I am short AMZN.