Over the past week, I have been reading and listening to every expert analysis of QE2 I can find on the web.
I have found four categories of analysis :
1. QE2 is the right thing to do and will work. The artificial effects will seamlessly segue into a real recovery -- at which point QE2 will be withdrawn.
2. QE2 must be done because the situation is dire and no alternatives are forthcoming. However, it is a very dangerous course to pursue.
3. QE2 is the wrong thing to do and will not work. Europe's approach is the correct one.
4. Who knows & who cares about the logic behind and efficacy of QE2. Fed wants higher inflation & weaker dollar, and will flood the system with dollars to get what it wants. Don't fight the Fed.
The common thread in all four categories ( from erstwhile bulls & bears alike ) is that none of these experts offer any sort of bounds for the short-term response to QE2. Almost nobody seems have any clue as to how long and how far the markets will rally.
The vast majority believe there is only one valid response to QE2 : the "risk on" trade ( long commodities and equities -- especially those of an emerging markets or commodity-linked kind ) should work for the duration of the monetary stimulus.
Those who like QE2 believe that inflating the markets is part of the plan.
Those who don't like QE2 cite potential problems far out in the future ( primarily resulting from misallocation of resources, inadvertently stengthening economic competitors, and bubbles ). But none of these mechanisms are thought to have any short-term negative consequences for the markets.
So what's not to like ? Why not just scrape up every spare dollar and buy calls on FCX GLD MOS PTR and other risk-on stocks ?
What bothers me is where is the Wall of Worry ? Where is the healthy bull market mechanism of two-sided risk where buyers must assume additional economic scenario risk in paying-up to extract shares from sellers ?
After all, there is no markets research evidence indicating that sellers are less intelligent than buyers.
( In fact, in a rising market, the opposite would seem to be slightly more likely : insiders accumulating windfall profits sell in advance of equity-specific upcoming events which will adversely impact a continued upwards trajectory. )
Clearly there is a seller for every buyer. So who is selling into this risk-on moonshot ? Are these people all morons ?
If no one can think of any reason to sell ( other than the obvious and ever-present motive to take profits ), and no one can think of any reason to not buy ( other than the obvious lack of liquid funds ), then aren't we already in a bubble ?
Isn't an absence of perceived economic scenario-risk the basic inflating mechanism of a bubble ? Where everyone wants in and the only risk is mis-timing episodes of profit-taking ?
I'm very surprised that the dozens of gurus I am reading do not seem to be able to elucidate any short-term risks to embracing the risk-on trade.
Wild optimism in markets has proven time and time again to be a destabilizing factor. Market tops are often established when selling shows up for no apparent reason, at a time when no one would anticipate it. Only later do the reasons become apparent.
The smartest hedge funds and prop traders know this. And many of them will be quick to unwind their leverage as soon as they see any sign of large sellers persistently hitting bids. Even if they don't know why it is happenning.
Just because apparently nobody can think of any danger to being leveraged long with QE2 at our backs, does not mean that destabilizing equations -- small but capable of rapid exponential growth -- do not exist in the dark recesses of the collective market mind.
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