I encourage readers to carefully read and analyze Federal Reserve Chairman Ben Bernanke's recent speech delivered at the Jackson Hole conference.
Here is my analysis:
1. Bermanke's message in a nutshell: QE has been successful in terms of stimulating economic growth in recent years, and it is likely to remain an effective policy tool under current circumstances. Therefore, as long as unemployment remains high, I will continue to recommend employing QE at any time that the economy is not growing above trend (required to get unemployment down) and as long as prices are stable.
2. What Bernanke has done here is articulate a very strong "Fed put." The put consists of a promise to stimulate the economy if it is not growing above trend, and as long as inflation remains low.
3. The speech is very "dovish." In that sense, it is as "bullish" a speech as the equity markets could possibly hope for. The only thing that could have been more "bullish" for the equity market is if he had said "QE 3 starts right now." But he actually does something far more "bullish" that announcing QE in the short term. What he has essentially announced is "QE forever," -- as long as unemployment is high and inflation remains low.
4. In my view, Bernanke really does not make a persuasive case for the effectiveness of additional QE. All he says is that empirical studies tend to show that QE worked in the past. Let's assume that this is true. But that is besides the point. Conditions change. It is likely that QE worked in the past mainly because liquidity was constrained. There is much reason to believe that it will work much less in conditions where liquidity is not scarce.
5. Bernanke acknowledges costs and risks to further QE. I think this is wise on his part. However, he essentially dismisses those concerns, at least under current circumstances.
For reasons detailed in my most recent published article, my view that as long as the US economy is not liquidity constrained, additional QE by the Fed will probably do more harm than good. However, people should not misunderstand me: I don't think another round of QE is going to cause hyperinflation any time soon. What I have said is that more QE jeopardizes future growth and stability (by making normalization more painful) and that it incrementally erodes the credibility of the Fed and the nation's currency.
Having said this, I want to make clear that for purposes of investing and trading in relatively short time-frames, the concerns I expressed in the aforementioned article are not paramount. What is paramount are Bernanke's views expressed in his Jackson Hole speech: Bernanke thinks that QE stimulates growth, that it does no harm under current conditions, and that it should be used as long as unemployment is high and prices are stable.
Unemployment is high, growth is below trend and inflation is low. Thus, expect more QE in the future. Perhaps quite a bit of it, for quite a while.
The cyclical protection implied in the Bernanke put may benefit cyclical stocks and ETFs such as Freeport McMoRan Copper & Gold Inc. (FCX); Cisco Systems, Inc.(CSCO) and the Consumer Discretionary Select Sector SPDR ETF (XLY), in addition to more general index ETFs such as the SPDR S&P 500 Trust (SPY); SPDR Dow Jones Industrial Average (DIA) and PowerShares QQQ Trust (QQQ).