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QE's Ending...Now What

Contrary to popular opinion, QE was never intended to, nor was it ever likely to solve the problems facing the US and global economies. Monetary policy is a very weak policy tool often described as "pushing on a string." If there was anything the Great Depression taught economists it was that:

1) You should never allow the banking system to collapse.

2) Monetary policy is not the tool to rely on to push and economy to growth.

Facts are, monetary policy is a "carrot" not a "stick." Its effect is analogous to leading a horse to water. You can lead a horse to water but you can't make it drink. With the extreme levels of uncertainty being created by Congress and the White House, businesses are simply reluctant to hire and expand, people fearing for their jobs and in homes that are underwater are fearful to borrow and spend and banks facing ever changing rules are reluctant to loan even if people wanted to borrow and spend.

No amount of appropriate monetary policy can compensate for dysfunctional fiscal policy. Unfortunately, the Financial media seems to have skipped class when that lesson was taught so they spend a disproportionate amount of time focused on monetary policy, where the real economically significant policy is fiscal policy. Monetary policy can stabilize the banking system and create an environment for growth, it can not create the growth. The main question the financial media has been totally ignoring is why, given 5 years of near 0% interest rates, hasn't the US economy picked up growth? What is different this time? Why isn't monetary policy having the stimulative effect that it has had in past times? Why is this time different? That is the question the media has been avoiding.

In reality what the Fed and Ben Bernanke have done is buy time for Congress and the White House to get their act together and address the real issues that are holding the American economy back. The Fed is analogous to an emergency room physician keeping the patient alive, whereas fiscal policy is like a physical therapist doing rehab on a recovering patient. The ending of QE represents the transferring of the patient from acute care to recovery. Each round of QE had less and less impact upon the patient, and the patient is now stabilized enough to transfer the patient to recovery. That should be viewed as a positive for the economy and markets, even if it results in marginally higher interest rates. When a wound is closed, the patient's blood pressure often increases, and that is a good sign that the patient is recovering.

With the ending of QE we will be returning to a period of "normalcy," and during normal time, fundamentals matter. Businesses will no longer be able to rely on monetary policy for support, they will have to stand on their own two feed. Most importantly, Congress and the White House will no longer be given cover for their ineffectiveness and inaction. A back-up in rates will cost the US Government extreme amounts of cash and make borrowing more difficult. Fortunately some in Washington are beginning to at least acknowledge that fact. Ben Bernanke has been saying for quite some time that fiscal policy needs to pick up the responsibility for recovery, and now he has support from the Bank of Internatioinal Settlement or BIS. Both Ben and the BIS are saying what should have been obvious to everyone from the beginning, but unfortunately Washington has done what it does best; it procrastinated and kicked the can down the road. Washington basically squandered the time the Fed bought for them, but the real problems the US economy faces can't be ignored, and can't be fixed with easy money and eventually the piper will need to be paid.

What then should investors watch for coming out of Washington that might move the markets:

1) Any form of tax reform that repatriates foreign profits, simplifies, broadens and lowers the tax rates would be well received by the markets. Lower capital gains, dividends and corporate tax rates would almost certainly drive the markets higher.

2) Clarity of regulation across the board would greatly help. Change has created uncertainty in the business community with new energy, healthcare, banking, labor and environmental regulations stalling recovery. Businesses simply won't act until the rules are known, and right now the rules are still being written.

3) Reform of entitlements and serious advancement on addressing the debt would also likely be well received by the markets.

In conclusion, with the ending of QE, fiscal policy will now likely become the focus as the tool of recovery. Until now America could ignore the real problems that it faced, and mis-direct its attention towards monetary policy. Those days are coming to an end, and investors should start to look forward and understand how changes in fiscal policy are likely to impact the economy, markets and their portfolios. Without having Ben Bernanke to kick around anymore, Congress and the White House won't have anymore scapegoats to persecute or witches to burn, and will have to start making the tough decisions needed to truly lead this economy to recovery. When that happens, the legislation that is written will likely have an impact on the markets, and it is important for investors to understand how those laws will impact their portfolios. The problem is, it is much easier for the financial press to focus on a single issue, interest rates, and it is much more difficult to understand the intricacies and impacts of new laws and regulations. Fortunately for Seeking Alpha readers, there are many contributors that dig through the details and report on the impacts of these new laws like this article does on how energy regulations are impacting biofuels companies. Understanding the impact of fiscal policy isn't as easy as monetary policy, but looking forward in my opinion it is the best way to generate market beating returns. Bottom line, with the ending of QE the easy money is in the past. Looking forward, returns are going to take a lot more research, hard work and an understanding of fiscal policy as well as monetary policy.

Disclaimer: This article is not an investment recommendation. Any analysis presented in this article is illustrative in nature, is based on an incomplete set of information and has limitations to its accuracy, and is not meant to be relied upon for investment decisions. Please consult a qualified investment advisor. The information upon which this material is based was obtained from sources believed to be reliable, but has not been independently verified. Therefore, the author cannot guarantee its accuracy. Any opinions or estimates constitute the author's best judgment as of the date of publication, and are subject to change without notice.

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.