“This is the most disrespected rally I’ve ever seen.”
John Buckingham, Al Frank Asset Management
Stock prices have rallied and are closing in on their highest level in five years. After six consecutive weeks of gains, the Dow Jones Industrial Average is up 9.7% since early June.
Any increase in stock prices is, of course, good news. But the market rally has little to do with market fundamentals. It’s not due to improved corporate earnings, higher employment or other economic news.
The market has been rallying based on the belief that The Federal Reserve Board will approve another round of quantitative easing.
A rally built on wishful thinking is a rally that should be approached with caution. Investors have, indeed, been cautious, withdrawing $70 billion from stock mutual funds since the year began. Likewise, trading volume has been low.
With the economy showing signs of tepid improvement, it is becoming less and less likely that The Fed will move forward with another round of quantitative easing (QE3). And if The Fed does not take action, investors fear that the rally will not only come to an end, but gains based on the potential for another round of quantitative easing will turn to losses.
So what will happen if The Fed moves forward with QE3? Like QE1 and QE2, it will likely have much, if any, economic impact. In fact, it’s a given that each round of quantitative easing will be less effective than the one before it.
Like previous rounds of easing, investors could expect stock prices to rise, as quantitative easing makes stocks more attractive relative to other investments. Except, given that the market has already rallied in anticipation of QE3, announcing QE3 may have little impact at this point.