The Markets have spoken

On Monday I wrote that this would be a momentous week for the financial prices and suggested that it may be time to sell the news. Now that the mid-term elections and the FOMC decision has come and gone, what's the verdict?

In the spirit of elections, where conceding politicians use the words "the People have spoken", I now write "the Markets have spoken."

Fed chairman Ben Bernanke had an important Op-Ed in the Washington Post, in which he admitted that the Fed was targeting stock and other asset prices [emphasis added]:

The FOMC intends to buy an additional $600 billion of longer-term Treasury securities by mid-2011 and will continue to reinvest repayments of principal on its holdings of securities, as it has been doing since August.

This approach eased financial conditions in the past and, so far, looks to be effective again. Stock prices rose and long-term interest rates fell when investors began to anticipate the most recent action. Easier financial conditions will promote economic growth. For example, lower mortgage rates will make housing more affordable and allow more homeowners to refinance. Lower corporate bond rates will encourage investment. And higher stock prices will boost consumer wealth and help increase confidence, which can also spur spending. Increased spending will lead to higher incomes and profits that, in a virtuous circle, will further support economic expansion.

When the Fed chairman mensions stock prices twice in the same paragraph, it would be foolish not to pay attention. In reaction, commodity prices are skyrocketing and the USD has fallen through an interim support level.

Substantial risks remain
My inner investor tells me that substantial risks remain in the market. First of all, there are the valuation and economic risks of a slowdown or double-dip, as the likes of John Hussman has repeated warned us about. Moreover, political gridlock may not be good for the markets after all. Bernanke concluded his Op-Ed with [emphasis mine]:

The Federal Reserve cannot solve all the economy's problems on its own. That will take time and the combined efforts of many parties, including the central bank, Congress, the administration, regulators and the private sector. But the Federal Reserve has a particular obligation to help promote increased employment and sustain price stability. Steps taken this week should help us fulfill that obligation.

If there is gridlock, then monetary policy will have to do all the heavy lifting. That will lead to a highly risky unbalanced policy by the United States.

More telling is Kid Dynamite's characterization of the comments of Bill Gross, which is "sold to you sucka" as a response to the Fed's QE2 program.


Don't fight the Fed
Does that mean that Bill Gross is fighting the Fed? Let's see what he actually said:

"To your question of selling or buying treasuries - I think for the most part those that should have bought them have bought them already and that would include PIMCO and that we would be looking forward to "handing them off" so to speak as we accelerate towards that outer orbit."

In other words, Gross and others front-ran the Fed in its QE2 program and is now "handing them off" to the Fed. If an institution the size of Pimco wanted to sell, the Fed would be a perfect candidate as a buyer. The rest of us mortals whose portfolios are a fraction the size of Pimco's AUM and the Fed's balance sheet can afford to be more nimble.

My inner trader, who vehemently disagrees with my inner investor, believes that the Fed is intent on blowing another asset bubble. Already, we have commentators like Barry Ritholz and Simon Johnson warning against the likely watering down of the Volcker Rule. Such actions, it is believed, will lead to a repeat of the financial excesses that toppled Bear Stearns and Lehman Brothers.

My inner trader says, "Don't worry, be happy! These policies are bubblicious. They are supportive of the asset bubble that the Fed wants to blow, so relax and go with the flow."

In that case, this will mean a momentum driven market where fundamental don't matter.