Praying for a QE3? Don't Count on it....Yet

Hmmm......So the Fed ends QE and the market tanks.

Haven't we seen this nightmare before?? 

My Take:

We sure have!
As you can see above, we have basically rocketed straight up from the lows except for a "soft patch" that we saw beginning in June of last year.  Coincidentally this was exactly when QE1 ended.  QE2 was not initiated until the fall.

Without the Fed Playing "Charles Ponzi" in the background the market corrected by about 15% over last summer before QE2 was initiated in September.

As soon as QE2 was cranked up Wall St loved it and stocks rocketed 30% higher by MArch.  However, as soon as the Fed announced this spring that it was leaving the QE party in June, the market has gone nowhere.

Like clockwork, once QE ended, the market is doing an exact repeat of what it did the last time QE ended:  It's TANKING!

The Wall St cheerleaders will soon be trotted out on CNBC to begin their ad campaign for QE3.   I am here to say it's not going to happen.  At least not for now. 

Why???

Well, thanks to the European debt crisis we have very strong demand for bonds so we don't need the Fed in the bond market.   Yields on the 10 year are crashing as scared money flocks into US debt from Europe as their crisis continues to spiral downward:

Folks, high interest rates are not a problem for the Fed when the 10 year sits at 2.6%!  The problem is unemployment and consumers that are being strangled by massive debt loads.

I mean think about what the average Joe consumer must be asking himself:

"Why should I put another noose around my neck when I am already in one as a result of being too deep in debt?  I already owe $200,000 on my school loan.  I never should have put $50,000 on my credit cards as I yucked it up and partied like it was 1999.  What in the hell was I thinking???"

This is what what the majority of consumers are asking themselves right now.  Many of them are jobless or have no job security.  Others have taken jobs that pay much less than the one they previously had as a result of this crippling recession.

The bottom line is the majority of Americans no longer have the ability or desire to borrow.

The Bottom Line

The Fed understands that credit/low rates are not the problem.  They also understand that oil rose from $20 at the lows up to $110 this year as a result of their QE printing exercises.

They also watched all other commodities soar as the currency weakened as a result of their printing Ponzi scheme.  Gold now sits at new all time highs once again today.

The also now understand the unintended consequences of taking such reckless actions....Arab Spring anyone?  Starvation in third world countries?  Soaring corporate input costs?

The bottom line here is there are many knowns and very few unkowns for the Fed after pulling this QE stunt twice since the 2009 lows.

Obviously, the stock market would love it but the Fed has to seriously ask themselves if this money printing is worth the price?  You all know my answer.

Making matters more tough this go around are the ratings agencies.  Any initiation of a QE3 would almost immediately trigger a debt downgrade from S&P and Moody's.  Both agencies are already right on the brink of taking away our AAA status without adding any additional stimulus in the form of QE3.

Who knows what unintended consequences this would trigger?

The Fed is running out of options.  If they pull the QE3 button then we will likely lose our AAA status, and run the risk of massive inflation as our currency takes it on the chin.

If they don't pull the trigger then we run the risk of a Japanese style deflation as we see historic debt destruction.

As you can see, the stakes are very high here and the downside risk of a QE3 are clearly understood by the Fed.  As a result, I expect the Fed to take their time figuring out what they should do.

If the market continues continues to completely unwind like it has in the past week then I think the Fed will eventually think about a third dose of QE heroine.  However, I expect them to think long and hard before doing so which means there is likely a lot more pain ahead when it comes to the stock market.

Disclosure:  Sold PUTS in PHM.  No new positions taken at the time of publishing.