No Quantitative Easing (Yet), Say Experts

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By Rudi Filapek-Vandyck

Don't do it. A growing queue of share market experts is advising the Federal Reserve Bank in the lead up to tomorrow's FOMC meeting to ignore market speculation and not give in to growing demands for more stimulus.

Most of these experts do acknowledge US economic data have been weak recently and the Fed is likely to lower economic growth projections, or express more concerns about it in its official statement. But starting up more quantitative easing programs at tomorrow's meeting equals opening Pandora's Box, say these experts.

Some suggest it might be better to disappoint the market now and come back with some quantitative easing later. But not tomorrow. Any action tomorrow would be seen, as BTIG market strategist Mike O'Rourke put it today, “as blinking in an almost panicky fashion”.

Out of all possible scenarios, the following ones should be considered most likely, according to O'Rourke:

– Either the Fed does nothing and there will be a negative short term reaction due to market disappointment that the Fed is doing nothing. After the market digests its fix of stimulus not being delivered, it should be interpreted as the Fed seeing its forecast as remaining on track despite recent events. The net result should be positive.

– Or the Fed implements Replacement Purchases. This risks becoming the worst outcome, in O'Rourke's view as the market may view it as the Fed conceding the economic weakness, but keeping the balance sheet status quo and not doing anything new about it. This is seen as a dangerous combination.

– Or the Fed says it is not implementing Replacement Purchases, but is re-opening the asset purchase program in case they decide they want to commence the Replacement Purchases (and any additional purchases they deem necessary) should the economic environment warrant it.

The final option is seen as the best one.

Says O'Rourke: “The most important thing for the FOMC to do tomorrow is to avoid falling victim to the game of market expectations. The market always indicates it wants an inch, but by the time it is done, it takes a mile. Chasing market expectations creates a negative feedback loop that then needs to play out. The healthiest course of action is to disappoint the market quickly and shake out the weak hands than create this game of chase that policy makers never win.”

Australian analysts at RBS Australia report their economists in the US believe the FOMC could start QE-2 at tomorrow's meeting, but they probably won't. In line with BTIG's advice, RBS believes the Fed will start preparing the market for some mortgage reinvestment action later.

Market strategists at RBS in Australia this morning updated their High Conviction Calls, including some recent changes made. Still on the Buy with a High Conviction list are Fortescue Metals ((FMG)), Suncorp-Metway ((SUN)), Origin Energy ((ORG)), MAp Airports ((MAP)), News Corp ((NWS)) and Southern Cross Media ((SXL)). These stocks have now been joined by retailer Myer ((MYR)).

RBS has at present no High Conviction Calls in negative direction.

Elsewhere, Citi's US based market strategist Tobias M Levkovich reports he has been genuinely surprised by how strong equities have performed these past few weeks. He points into the direction of a positive results season in the US, but also to short covering.

Now that the effect from US corporate results is ending, Levkovich predicts any follow-up will have to come from economic data and the US dollar. He suggests investors should be in no hurry and “better entry points” should present themselves later this year.

Interestingly, on his analysis, the rally from June till now seems to have found inspiration from the fact that company downgrades to outlooks have been far less than usual. While the short term is likely to see more upgrades to earnings forecasts, Levkovich also suggests this might be a temporary phenomenon only.

History shows lending standards tend to lead industrial activity by nine months, reports the Citi strategist, adding “data on lending standards is flattening out arguing for far less growth next year”. His conclusion is thus that as industrial activity moderates, so do earnings, and margins also could ease back.

Another interesting observation Levkovich makes is that buy-side money managers in the US expect only 9% EPS growth in 2011 while estimates on the sell-side are closer to 18% growth. One of both is going to be wrong, but which one?

Levkovich also joins so many other market experts in pointing out that sentiment indicators and technicals remain deeply supportive of more share market gains. Hence why Citi remains a buyer on pull backs.

The stockbroker has moved to Neutral on stocks of miners and materials companies as the previous valuation gap has narrowed considerably over the past weeks. One interesting factor in this shift is that Citi suggests USD weakess may now have largely run its course (3-6 months view).

Another interesting observation is that Citi suggests current market conditions do not provide a supportive background for gold, with the precious metal expected to remain unable to break above its June high of US$1,250/oz in the near term. However, support at US$1,150/oz should prevent the metal's price from dropping too steeply.

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