It seems QE 1 and 2 have been able to boost stock prices and commodities. But there will be problems with this as input costs have increased significantly, and my guess is that businesses that use the raw materials in end products have not been as quick to raise their prices. I realize this is a huge generalization that should be backed with more evidence. However, as a thought experiment, what does this mean? Let’s assume prices have raised a little, but not as much as their input costs have risen. The overall effect would be more revenues but less profit. Right? In an even worse scenario, what if businesses lower their prices to drive demand because consumers don’t buy at the raised price? Even less profit. This is called margin compression. If this occurs in the next few quarters, the stock market should drop.
If this happens, how far will the market tank? How far will the Fed let it drop? Would it be grounds for more QE? These are good questions to be asking oneself to setup some trades. Unfortunately I have no conclusions in this scenario, but let’s explore a little. I am going to assume that the Fed’s top priority is that the major banks stay in place since the Fed has been protecting the banks all along. Let’s assume for the time being that banks won’t be the next major issue in the next few quarters (although they could be due to mortgage putbacks, law suits from states, investors, foreclosure victims, etc.) but that the real economy is hurting due to compression. But what will they do to prop up the real economy? Do they have any power in this regard? Assuming prices have increased while wages have not, how does the Fed get money into the consumers hands? Does QE (giving money created out of thin air to banks in exchange for debt/bonds) get money to consumers? Yeah sure, stocks would probably go up, but do most consumers even own stocks? Do lower interest rates give more money to consumers? Maybe if people can refinance their debts, but as we have seen, this isn’t happening significantly. My parents certainly have not been able to.
The point is, if it doesn’t work (and it probably won’t), the rich will get richer and the poor will get poorer.