Pragmatic Capitalism

Capital for Living a More Practical Life


Apparently I am not the only one who took issue with David Tepper’s comments that the market is now in a “win win” situation.  In today’s note, David Rosenberg says Tepper is not necessarily right.  Rosenberg believes Tepper is ignoring a potential third scenario (aside from his “win win” scenarios).  This of course, is the scenario I have repeatedly discussed – QE won’t work.  Rosenberg says:

“Too bad we weren’t invited as a guest on CNBC last Friday to engage in a friendly debate with this portfolio manager because he didn’t outline the third scenario, either because he doesn’t believe it or he just plain didn’t contemplate it or he’s simply not positioned for it.  That third scenario is that the economy weakens to such an extent that the Fed does indeed re-engage in QE, but that it does not work.  So the “E” goes down and the P/E multiple does not expand. Maybe it even contracts since it already has spent the past number of years reverting to the mean as are so many other market and macro variables (for example, the dividend yield, savings rate, homeownership rate and debt ratios). In this scenario, the stock market does not go up; it goes down.

Is it possible that QE2 won’t work?  The answer is yes.  How do we know?  Well, because the first round of QE didn’t work.  After all, if it had worked, the Fed obviously would not be openly contemplating the second round of balance sheet expansion.  If the objective was narrow in terms of bringing mortgage spreads in from sky-high levels, well, on that basis, it did help.”

I don’t entirely agree here.  QE1 worked because we were in a different environment.  The problem Bernanke was targeting in 2009 was one of bank balance sheets.  Bank balance sheets were loaded with toxic assets so replacing these assets with cash was most certainly beneficial.  It eliminated much of the risk associated with the banking system.  As Bernanke said at the time, the point of QE was to alleviate pressures in the credit markets.  As we can see from credit spreads he certainly succeeded in this regard.  But this is no longer the environment we are in.  As I said last week there are no bank balance sheets to fix.  There is no credit system to fix.  At this point, the only real fix is to generate real aggregate demand.  QE WILL NOT DO THIS.  This is clear from the first round of QE.  Japan’s long history with QE also confirms this.  Rosey elaborates:

“But it did not revive the housing market any more than the litany of other government programs, and the fact that the economy has slowed so sharply to near stall-speed in recent quarters is all anyone needs to know about the true success, or lack thereof, from the first round of QE. The Fed has cut its growth forecast twice in the past three months and has sliced its inflation forecast three times.  This was not was envisaged when the first round of QE was unveiled last year.  Normally, the pace of economic activity is accelerating to over a 5% annual rate in the second year of recovery, not slowing down to below 2% — especially with all the monetary, fiscal and bailout stimulus that is in the system.

Here’s the bottom line: if not for the stimulus and the inventory swing, the economy would have actually contracted this year.”

QE is not a “win win” situation. It is a desperate last ditch effort by a Fed that has no more tools left to utilize….

Source: Gluskin Sheff

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