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Why The Best Thing For Stocks Might Not Be An Absence Of Quantitative Easing

|About: SPDR S&P 500 Trust ETF (SPY)

Just today I saw this piece of news where Jim Paulsen, Chief Investment Strategist at Wells Capital Management, advances the theory that the best thing for stocks would be an end to Federal Reserve's recurrent stimulus programs.

The notion is that the fundamentals have been treated, and there remains only a confidence crisis which would be better served by FED's removal from the scene.

I disagree. This view ignores a very basic fact. The fact that the U.S. is still running huge twin deficits, both a fiscal deficit and a trade deficit. The fiscal deficit should be close to 10% of GDP. What this fiscal deficit did, was it replaced the private sector in taking prodigious amounts of new debt year in, year out. So at this point the U.S. economy is not much different from what it was back in 2007, it's still addicted to the continuous increase in debt, only right now it's the U.S. Federal State that's providing for the issuance.

What happens here, is that this continuous increase in debt issuance is only somewhat sustainable due to the fact that the Federal Reserve comes in periodically and wipes a large swath of it off the map, through quantitative easing. If the U.S. were to have no recurrent quantitative easing it wouldn't be able to keep the large fiscal holes year after year, and thus the U.S. economy - and profits, and the stock market - would have to take a new hit. Only then would the economy really be weaned off from the sugar.

So right now the stock market is, indeed, vulnerable to the lack of further quantitative easing in as much as the fiscal deficit might not be sustainable without it and without the fiscal deficit the economy's true equilibrium level lies lower.

Still, it could take a while before the S&P500 (NYSEARCA:SPY) realizes this connection. After all, the U.S. debt/GDP ratio ended 2011 at around 70% (including only debt held by the public), which is still lower than Germany's and a full 1/3 of Japan's.

I'm not saying quantitative easing is a good thing, but it does take the market higher, and in its absence the market might well stagnate or drop.

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.