Lombardi: Stock Market Commentary & Forecasts, Financial & Economic Analysis Since 1986

Why QE3 Hasn’t Delivered the Same Stock Rally We Got After QE1, QE2

Thursday, October 4th, 2012
By for Profit Confidential

Business Man ShrugAs the stock market rally continues and the risks keep piling up, the bear market rally that began in 2009 is losing momentum.

Looking at the chart below of the S&P 500, it paints an even prettier picture than the Mona Lisa.

Some well-known stock advisors are saying the stock market rally will continue and are telling their clients to buy. The problem is that they may be only looking at index and stock charts alone and ignoring the underlying issues of the market.

Even though the uptrend on the S&P 500 continues, the fundamentals are screaming that such will not be the case for too long.

spx s-p 500 large cap index

Chart courtesy of www.StockCharts.com

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We have seen the stock market rally months after the Federal Reserve’s announcement of the first and second rounds of quantitative easing, QE1 and QE2. Shouldn’t it be the same with the third round, QE3? Maybe not this time. You see, the announcement of QE3 was widely expected and discounted by the stock market. The unknown “news,” and what gave stocks a lift, was the open-ended nature of QE3; the Fed didn’t give us an end date for QE3.

Hence, the market was already anticipating more quantitative easing—already knew the Federal Reserve would print more money. Now, with the fundamental economic data being released so weak, what will propel stocks higher? QE4? Forget it; while QE4 will be needed, it’s far off in the distance.

A key indicator called the “Volatility Index” (VIX)—also called the “fear index” for the S&P 500—is showing some interesting developments.

The S&P 500 and VIX have an inverse relationship. When the S&P 500 goes up, the VIX goes down.

When the S&P 500 reached a new 52-week high in mid-September, historically, because of their inverse relationship, the VIX should have gone lower.

As any technical analyst would tell you, when a market is in an uptrend, you will see more stocks making new highs and fewer stocks making new lows. With a downtrend, it’s the opposite—more stocks making new lows and fewer stocks moving to new price highs.

While the S&P 500 made greater highs, the VIX failed to make new lows. The VIX made its 52-week low in mid August and did not break lower when the S&P 500 reached new highs in September.

volatility index new methodology

Chart courtesy of www.StockCharts.com

Obviously, time will tell if the action of the VIX has been a leading indicator or a market reversal. Advocates of the S&P 500 reaching 1,500 should be cautioned.

The S&P 500 chart looks to be climbing; but, as the stock market rally continued, volume was decreasing, insiders were selling their stakes in the companies they work for, and the VIX was working against the market. These are all not the signs of healthy stock market rally. Be very careful with this market.

Michael’s Personal Notes:

At this point, it is no secret that the eurozone’s situation has taken a heavy toll on the global economy. Since the credit crisis in the eurozone began, ripple effects have been felt around the world. Countries were already struggling to find economic growth after the American financial crisis of 2008; the eurozone credit crisis simply added to their woes.

The cause of the credit crisis in eurozone countries is not a surprise. Many of the 17 eurozone member governments earned little revenue (taxes) as property prices fell and individuals/companies made less money, while those same governments spent more than they received. This resulted in higher national debt.

Now there is a growing body of evidence that some eurozone countries are still struggling with the same problems that led them into the credit crisis in first place. These governments are still unable to control their expenses and are failing to implement the sort of austerity measures the European Central Bank (ECB) has announced it wants in return for buying bad debt.

We have already discussed in these pages about Spain’s situation. One of the biggest gross domestic product (GDP) contributors in the eurozone is having troubles implementing austerity measures, because its citizens don’t want them.

Greece’s government has failed multiple times in enacting austerity measures. Now that it needs another round of funding to pay for its expenses—it is struggling once again—eurozone countries want the Greek government to implement more cuts to the deficit.

Greece, Ireland, Spain, and Italy are just few of the eurozone countries that have spent beyond their means for years and borrowed too much. They simple can’t afford to pay for their expenses anymore and they don’t have any options other than to beg for a bailout.

France’s government has announced that it will impose an income tax of 75% on peoples’ earnings that are over one million euros per annum. In addition, the government is planning to reduce its spending, so it can bring back the budge deficit to 3.0% instead of 4.5% of GDP in 2012. (Source: Newsmax, September 28, 2012.)

The U.S. national debt has increased significantly following the credit crisis—over $16.0 trillion now and increasing every passing second. The U.S. budget deficit has increased exponentially, trillion-dollar annual government deficits have become the norm, a record amount of people are on food stamps, unemployment is a huge problem in this country, and average Joe American is feeling the pain.

If proper steps are not taken soon, we might start looking a lot like the 18th eurozone member—with our creditors asking us to start implementing austerity measures, raising taxes, and cutting our pensions.

Where the Market Stands; Where it’s Headed:

Unbeknownst to most investors, we are at one of the most critical points in this generation’s stock market history. The Dow Jones Industrial Average opens this morning at 13,494, about 670 points below its all time high hit in October 2007 of 14,164.

If the Dow Jones Industrial Average breaks significantly past 14,164 through to a new high, we will have a confirmed new bull market on our hands. If the stock market doesn’t break through to the new high, we will have confirmation that the stock market has spent the last five years creating the right shoulder of a classic head-and-shoulders pattern.

This means the stock market has put in a huge top that will remain in place for years to come and that all we have been witnessing since March of 2009 is a bear market rally—which is my belief.

What He Said:

“Why Google stock will go higher: Most investors in Google, surprisingly, are retail investors.  And that’s why the stock can go higher—because only 20% of the stock is owned by institutions. If the institutions jump in and buy Google, the stock will certainly move higher.” Michael Lombardi, Profit Confidential, June 2, 2005. Michael recommended Google stock as a buy on June 2, 2005, when the stock was trading at $288.00. On November 5, 2007, when Google reached $700.00 U.S. per share, Michael advised his readers to sell their Google stock and to put the proceeds into gold-related investments. Coincidently, gold bullion was also trading at about $700.00 per ounce in November 2007. Michael’s message was to trade each $700.00 share of Google into $700.00 of gold, because he saw gold as a much better investment.

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Michael Lombardi - Economist, Financial AdvisorMichael bought his first stock when he was 17 years old. He quickly saw $2,000 of savings from summer jobs turn into $1,000. Determined not to lose money again on a stock, Michael started researching the market intensely, reading every book he could find on the topic and taking every course he could afford. It didn’t take long for Michael to start making money with stocks, and that led Michael to launch a newsletter on the stock market. Some of the stock recommendations in Michael's various financial newsletters have posted gains in excess of 500%! Michael has authored and published over one thousand articles on investment and money management. Michael became an active investor in real estate, art, precious metals and various businesses. Readers of the daily Profit Confidential e-letter are offered the benefit of the expertise Michael has gained in these sectors. Michael believes in successful stock picking as an important wealth accumulation tool. Married with two children, Michael received his Chartered Financial Planner designation from the Financial Planners Standards Council of Canada and his MBA from the Graduate Business School, Heriot-Watt University, Edinburgh, Scotland. Follow Michael and the latest from Profit Confidential on Twitter or Add Michael Lombardi to your Google+ circles