The Stock Market and Investor
Sentiment Tank—QE3 Anyone?

corporate earningsNot only was the latest jobs report terrible, but the trading action in the stock market has been as well. Investor sentiment has eroded its positive stance at the beginning of the year and there’s not much hope for any meaningful upside right now. The S&P 500 Index has been going down since the beginning of April and, below 1,300, it is very much at risk of further downside. The old adage, “Sell in May and go away,” looks very applicable this year. (See S&P 500 Trading at April 1999 Level—What this Means for the Investor.) I doubt the stock market can experience any sustainable rebound for the rest of this month, save for a third round of quantitative easing (QE3).

At the beginning of the year, the stock market got words of support from the Federal Reserve, which changed investor sentiment on a dime. All of sudden, the stock market was going up again, trading similarly to the action around the same time in 2011. Nothing had really changed when the S&P 500 Index broke above 1,400; investor sentiment was still mostly positive. Then the economic news started to trickle in revealing slowing growth in China and virtually no growth in Europe. Investor sentiment then took it on the chin over renewed concerns about Greece and, in very short order, the stock market’s impressive gains since the beginning of the year were wiped out. It’s a tough environment for all asset classes right now.

It’s an election year in many mature economies and I wouldn’t be surprised at all (for better or for worse) if the Federal Reserve initiates some form of QE3 or other stimulus to make stock market investors feel better. The Federal Reserve has been gifted at helping turn investor sentiment, providing the stock market with exactly what it wants to hear. This may not be the soundest policy but it does work in the short term. As I say, don’t be surprised if the Federal Reserve becomes extremely accommodating in the near-future—it’s the only catalyst as I see it that can move the stock market substantially higher. At the end of the day, more quantitative easing will likely be inflationary, but then again, that’s what the central bank’s been trying to do all along.

Investment risk in the stock market remains the same as it’s been for some time now—very high. Expectations for corporate earnings are coming down, but this will be the cause of “earnings surprises” over the coming quarters. Investor sentiment is weak, but it isn’t dead. If the Federal Reserve takes new action (which I think it will), then the stock market will soar, whether the fundamentals warrant it or not. Think of QE3 as kind of like short-term gain for long-term pain. I wouldn’t be surprised at all.

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