STOCKS MUST NOT RELY ON QE STIMULUS

 
David Morris
CFD MARKET STRATEGIST, GFT

AS WE head into the new year, there are a number of significant financial and economic issues still unresolved. The most immediate problem is the European debt crisis. The potential insolvency of many banks and the high levels of public debt of many member states will continue to weigh on the Eurozone. The inability of governments and the European Central Bank (ECB) to agree on a plan of action should ensure instability for the first half of 2011 at least.

Emerging markets continue to enjoy growth rates that developed economies can only dream about, but inflation is showing up to an alarming degree. There is every chance that we will see an escalation in the currency wars that Brazil’s finance minister warned about back in September. Last month’s Chinese inflation data caused investors to prepare for lending curbs or rate rises. China blames these inflationary pressures on the US Fed’s appetite for quantitative easing (QE), while US policymakers still blame China’s currency peg for the US trade deficit. This has seen the Shanghai Composite lose 11 per cent since the start of the year, in contrast to 10 per cent gains in the Dow and the S&P.

At the beginning of last year, speculation focused on when the US Federal Reserve would begin to wind down its quantitative easing programme. Now, QE-lite and QE2 continue to goose asset prices on a daily basis. QE2 is due to run out in June, but speculation is rife that QE3 is on the cards. There has been an improvement on a number of economic measures, but the jobless rate still stands at 9.8 per cent, while the housing market continues to deteriorate.

If these key metrics fail to improve significantly over the next quarter, the argument for further stimulus gets stronger. But the new Congress may be less willing to add to the US’s debt so more intervention cannot be relied on. For investors who see QE as a backstop for equities, the next few months may necessitate a reassessment. Happy New Year!