The Week Ahead: Hype About End of QE2 is Overblown

April 18th, 2011
in contributors

helicopter-dropping-money  by Jeff Miller

One of the main attractions in my career change from college professor to the financial markets was the ability to profit from situations where the conventional wisdom was wrong. This is especially true when the emotional realm of politics confuses many about their investment decisions.

Follow up:

This is how I feel right now.

Long-time readers know that these are favorite themes.

Here is an example I used in class. You have a person in the middle of a traffic intersection with a stoplight. When the light turns green in a given direction, he waves the traffic to go through. The actions of the guy doing the waving are perfectly correlated with the traffic movement, but there is no causation.

Now let us suppose that the traffic light is out, and the person in the middle is wearing a police uniform. The inference of causation is quite different.

Proving causation requires more than showing a correlation. It requires solid evidence of timing, one variable leading another, and also a strong hypothesis about the logic of causation. It is also useful to have statistical controls. Art Cashin is on target when it comes to the floor trader attitudes, but they might all be fooled by a spurious relationship.

I have been studying the sideshow about the deficit, the Fed, and the end of QE II. As I do in these weekly pieces I share my conclusions -- often dealing with concepts that I will write more about. With that in mind, here is my conclusion:

The End of QE II = Y2K

Much ado about nothing. For those experienced enough to remember, the Y2K worries just did not happen, although many wise people laid out plenty of fears. As I analyze the QE II data, I think there was a modest direct impact and also a secondary impact on confidence. The end of QE II will be similarly modest, except for the anticipatory trading. I continue to ponder this wheel within a wheel...

This issue will be with us for the next two months. As I write this, the Seeking Alpha top stories are about selling in May, selling in June, and selling in anticipation of the end of QE II.

I explained why this was the wrong idea earlier this week.

Sunday's Chicago Tribune carried the weekly poker column by Steve Rosenbloom. There is no link so far to Sunday's column, but the gist was a pro at the WSOP reading the bets of another player and extracting the max from his hand. He knew that the other player was a "weak hand" because he was wearing the official tournament wristband showing that he was a player. The pros do not do that.

This explains my excitement. I see a lot of people wearing wristbands!

Joining Twitter: A Small Note

After observing the usefulness of Twitter for many participants at the Kauffman conference, I have decided to give it a try. The first day I elected to "follow" a number of blogging friends and some leading economists of all stripes. Moments later I got an email saying that Paul Krugman was following me! THE Paul Krugman -- just waiting for Jeff to start tweeting so that he could have my perspective for his NYT columns:) A closer look showed that Prof. Krugman had about 18,000 followers and also follows a similar number. Clearly this was a lesson in how to use Twitter!

I had some fun by forwarding this to a few academic friends of the liberal

persuasion, who all congratulated me without seeing the joke. It is difficult to convey humor on the Web -- even with friends.

I am not going to tweet about small stuff, but I will try to think out loud -- willing to be wrong. Last week I noted tweeted that if the Obama speech on the deficit was a barrier to compromise, the sell off in defense stocks was unwarranted. The next day Citi's analysts came to the same conclusion.

My current thought is to mention ideas, possibly half-baked, reactions to some events, interesting articles, and other items that I might never write a full piece about. I have no idea how this will work out, and I invite feedback. @dashofinisght is the Twitter name. Feel free to offer advice, and thanks to readers who already have.

Background on "Weighing the Week Ahead"

There are many good services that do a complete list of every event for the upcoming week, so that is not my mission. Instead, I try to single out what will be most important in the coming week. If I am correct, my theme for the week is what we will be watching on TV and reading in the mainstream media. It is a focus on what I think is important for my trading and client portfolios.

In most of my articles I build a careful case for each point. My purpose here is different. This weekly piece emphasizes my opinions about what is really important and how to put the news in context. I have had great success with my approach, but some will disagree. That is what makes a market!

For those wanting a detailed review you can check out one of the following featured sources:

  • Steve Hansen at Global Economic Intersection (where I am a contributor).
  • The Bonddad Blog, a source I read daily since the authors provide data and analysis I do not see anywhere else.
  • The Bespoke Investment Group, with a nice chart showing expectations and results.

Last Week's Data

The news was mixed, but with a strong finish to the week.

The Good

Most major economic indicators show that the US economy has returned to its normal state, self-sustaining growth. Many seem to have forgotten that economic growth is normal, including the use of slack resources to expand and to build new businesses.

  • Economic growth forecasts improved. The ECRI Weekly Leading Index declined very slightly, to 130.5. The growth index moved higher to 6.8%. These continue to be good readings. Everyone is watching the indicator closely, mostly with the idea of bailing out at the first downtick. There is no empirical basis for that interpretation. We are doing our own research on the indicator.
  • Risk as measured by the St. Louis Fed Stress Index, remains very low. This measure tracks a lot of market data in the eighteen inputs. It is not a poll, nor opinions, nor a collection of anecdotes. We should all pay attention to some real data. The value moved to -0.085, a bit lower than last week's -0.03 (adjusted). These are completely normal readings for a scale measured in standard deviations from the norm. For more interpretation, the St. Louis Fed published a short paper with a very nice chart that helps to interpret this index. The chart does not reflect the recent continued decline in stress, but it identifies the dates for important recent events. The paper also has a longer version of the chart, illustrating past stress periods. I am not going to run the chart each week, but I strongly recommend that readers look at the paper. In the 2008 decline there was plenty of warning from this index -- no sign right now. The scale is in standard deviations, so anything short of 1.0 or so is neutral territory. I am doing more extensive research on this indicator.
  • Job Openings Increased Dramatically. This story was given little attention by the media. The lack of understanding of employment dynamics by big-time media sources puts investors at a real disadvantage. Here is the point: There are more than 4 million job openings, a month-over-month increase of more than 12%. More people quit jobs than are laid off or fired. Most people do not know these facts, since they go unreported. The JOLTS report is a good source for underlying labor dynamics.
  • Current inflation reports were encouraging. Core CPI, the basis for policy making, remained very tame. One of the single best things an investor can do is to learn about this subject. To be clear, I fill my tank, by groceries, pay for a son in college, experience first-hand the increase in health insurance costs for my business, and did not save enough on my iPad to make up for it! I'll try (once again) to write more, but you can start with this nice piece by Mark Perry, one of our featured sources. Mark shows why you should not look at commodities and headline prices when trying to analyze inflation trends.
  • Inflation expectations are tame. The Cleveland Fed has a calm, data-based measure. What do you think the ten-year expectaion is for inflation? The answer is at the end of the article. If you do not know it, you are at a big disadvantage in your investing.

NB: The ECRI and SLFSI are actually readings from week-old data.

The Bad

The biggest negative was the continuing spike in energy prices.

  • Energy prices move higher. Gasoline prices were up seven cents in a week and twenty-nine cents in one month. It is over $4.10/gallon here in Naperville and over five bucks in some places. This price increase directly affects other discrectionary spending.
  • Initial jobless claims spiked higher. We are back to the 4-handle. This series is only one part of the employment story, but everyone agrees on the significance. It is a real-time data series from a good source. I follow it closely, and the story has not been good.
  • The reaction to earnings has been poor, as I predicted last week. There is a high level of skepticism. The early reporting companies have lost ground, measured by stock price, even with an earnings "beat."
  • Housing, by any measure, remains very poor. A flat housing market would end the drag of more than 1% on GDP. A real turnaround would be better. I am not expecting any immediate good news.

The Ugly - Confirmation Bias

The ugliest thing I am seeing is "indicator shift." This happens when a pundit builds a theory on some indicator and then the indicator message changes. This is happening with the VIX index. I saw it last week and with this heads up, you will too.

Observers who think that stocks should be trading lower because of their laundry list of "headwinds" are astounded that the VIX index does not agree. The VIX is an objective gauge of volatility based upon thousands of transactions in the deep and liquid options market. The traders at the CBOE, my old stomping ground, and other exchanges will gladly welcome those who think there is something wrong with the VIX, just as the Vegas casinos will send a limo for them if they have a system for craps or roulette.

In the era where there is little curation or editing skill, you are on your own in interpreting these articles!

Our Own Forecast

We base our "official" weekly posture on ratings from our TCA-ETF "Felix" model. After a mostly bullish posture for several months, Felix has turned much more cautious. We shifted from our neutral posture to bullish last week, and we continue that posture in the weekly Ticker Sense Blogger Sentiment Poll, now recorded on Thursday after the market close. This is based on improved ratings in the various index ETFs, as well as the general trend. Here is what we see:

  • 86% of our 56 ETF's have a positive rating, about the same as 89% last week. This is very encouraging.
  • Only 61% of our 56 sectors are in our "penalty box," down dramatically from 93% last week. This is an indication of elevated short-term risk, but the picture is improving.
  • Our universe has a median strength of +30, down slightly from +35 last week.

The overall picture improved last week. We are back to 100% invested in trading accounts, since there are many attractive sectors. We noted this likely change last week.

[For more on the penalty box see this article. For more on the system ratings, you can write to etf at newarc dot com for our free report package or to be added to the (free) weekly ETF email list. You can also write personally to me with questions or comments, and I'll do my best to answer.]

The Week Ahead

On the economic front we will see housing data of various types. I like the building permits as a serious leading indicator.

Earnings are most important, and I'll stick with my preview from last week. So far it has been a winner. Any company that is cautious about revenue outlook or margins will get roasted by analysts, media, and invstors.

Investment Implications

I have three considerations:

  1. The basic investor fears -- distorted by those with a political or sales agenda -- are exaggerated.
  2. The reality -- from sources like the Cleveland Fed -- show that inflation expectaions are still below 2%. (Even I was surprised by this one. I am taking the "over" but that generally means less in bonds and more in stocks.)
  3. Most importantly -- this is a Y2K type of problem. There is a lot of highly-publicized and mistaken hype, creating a lot of fear. The big question is how a savvy investor should play this. What timing is right?

The earnings story is important, but I expect a skeptical reception. Any company without strong guidance may see a weaker stock price. Any company that talks about negative effects from energy costs will see a lot of publicity and plenty of selling. I am still buying on specific opportunities, but I expect mixed trading over the next two months.

Charles Kirk - -my go to source as the best trader perspective on the Web -- is still looking for a break from the current range. His weekly chart show is invaluable for anyone trying to time an entry or exit, or looking for a trading perspective.

Related Articles

Chilling Head winds:  Energy Costs Stalling the Economy?  by Steven Hansen

China Stops Buying U.S. Debt?  It Could be a Good Thing  by Michael Pettis

Getting Ready for the Week Ahead  by Jeff Miller


 Jeff Miller has been a partner in New Arc Investments since 1997, managing investment partnerships and individual accounts.  He has worked for market makers at the Chicago Board Options Exchange, where found anomalies in the standard option pricing models and developed new forecasting techniques.  Jeff is a Public Policy analyst and formerly taught advanced research methods at the University of Wisconsin.  He analyzed many issues related to state tax policy and provided quantitative modeling which helped inform state and local officials in Wisconsin for more than a decade.  Jeff writes at his blog, A Dash of Insight.



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  1. Derryl Hermanutz Email says :

    I don't share Jeff's optimism about the end of QE2. Who will buy $100 billion per month of Treasuries to fund government deficit commitments after the Fed stops buying? Will the primary dealers (PDs) simply buy and hold this additional quantity of Treasuries each month, rather than their QE2 practice of buying new Treasuries then selling them to the Fed a short time later?

    If the Fed stops monetizing Treasuries, and if the PDs won't or can't lend $100 billion per month to the government, I can't believe private investors will buy that amount of debt at current
    negligible interest rates. Bill Gross certainly won't
    be buying them. Japan is going to be needing reconstruction cash, not more Treasuries. China appears to be cashing in Treasuries and buying commodities. I think failed bond auctions in July are a strong possibility. That, or dramatically higher interest rates to attract buyers.

    Neither of these is a benign outcome. I'd be interested to know why Jeff does not share these concerns.

  2. Explorer says :

    Maybe nothing happened at Y@K because billions of dollars were spent world wide upgrading and replacing computer hardware and software to ensure that there were no problems.

    Companies auditors were checking that companies were implementing plkans to ensure they and their critical suppliers had virtually no risk from possible Y2K issues.

    Maybe it was all overkill, maybe it needlessly brought forward systems and hardware replacement by a few years, but it is an unlikely basis for an analogy with the end of QE2.



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