HUMMONEY - Short Term Mindedness (Perspective)

photo courtesy Washington Times- by Greg Lewin

Since Ben Bernanke, the Chairman of the US Federal Reserve Board, announced his new program of Quantitative Easing at the Jackson Hole Economic Symposium in late August 2010 called QE2, the stock market has had a dramatic change of fortunes, turning a 2010 January – August  loss of 5% into a roaring 18% gain.  Now it is true that it can be misleading to attribute specific moves in the markets to any single event, but in this case the correlations look extremely strong and in fact can be traced to daily interventions conducted by the Fed in the markets that have led, by some measures, to a rally of unprecedented strength, length and consistency. Therefore, it behooves us as investors to examine this program and its merits a little more closely.

QE2 is a rather simple policy that effectively exchanges higher yielding assets held by banks and replaces them with lower yielding assets. So the Federal Reserve takes on the obligation of an interest paying obligation and the bank now must look for another way to create returns lost. The catch is that in the process the Fed in effect has created a low to no interest rate environment and the only place for investors to locate returns is by accepting higher levels of risk than those often found in fixed rate instruments. If we examine the overall picture of economic health since the inception of this program we see little uniform relief. Many measures have continued to deteriorate such as employment and housing and others such as real GDP (when stripped of government stimulus) and credit have at best stagnated. Therefore, by definition, if fundamentals are little changed and investors are accepting more risk by exchanging fixed rate investments for equity investments they are in effect speculating and this is never healthy.

The original quantitative easing program which began in the heart of the financial crisis was a $1.7 trillion program focused on bringing stability to the free falling mortgage-linked debt markets and thereby aiding the banking system. In contrast, QE2 had been launched with the hope of stimulating growth. But close examination may raise important questions about the impact of this growth.  For the 2 clear areas of economic growth we have seen over the past 6 months have been the price of stocks and the prices of commodities and these 2 asset classes lead to very different and troubling outcomes.

Since we know that 10% of American families control approximately 90% of investible assets, stock market gains are clearly concentrated in the hands of the few. Assuming these are the families least likely to be suffering the stress of the financial crises, it can be assumed that this incremental capital is likely saved or spent on highly discretionary purchases, not necessarily the investments necessary to drive employment and business formation. However, if we look at the other alleged by- products of the Fed’s promotion of speculation, investments in commodities have led to steep rises in commodity prices such as gasoline, home heating fuel, agricultural products and a whole host of metals. Different than stock price appreciation we know that these price increases directly and disproportionally impacts those already in stress.

So we seem to be walking down a path we have walked before. As we review earlier policies of financial intervention, complaints were loud and clear that the banks got relief that they used to rebuild their health and wealth (bonuses) while the individual and small business owners floundered. And now much of the same (albeit with slightly different actors) seems to be taking place. When does the failure of these policies to address the real issues of employment, growth and inequality begin to stress the economic platform on which we all dependent?

Long term investing is predicated on a sound alignment of fundamental progress and stock price movement. Therefore investors must judge whether the policies driving our stock market movements are worthy and sustaining.              

 ---The views expressed here are of the author, HUMMoney contributor Greg Lewin; currently a General Partner at TLF Capital, an investment management firm. During the past 26 years he has been a senior money manager or partner in Wall Street firms including Neuberger Berman, Charter Oak Partners and Sailfish Capital.