This week’s stock market trading demonstrated once again investors’ Pavlovian response to hints of additional government rescue or stimulus.
In recent weeks stock prices have risen or fallen in concert with prospects for the success of the pending Greek debt rescue. For some time, while acknowledging the seriousness of the debt crises in peripheral European countries, analysts have made the case that apprehension would intensify should Spain or Italy be added to the mix. Conditions in both of those countries have worsened, and the near-term rollover of Italian debt became the financial cause celebre early this week. The debt cloud growing over Italy and the ramifications it could have around the world knocked Dow futures down about 150 points in Tuesday’s pre-dawn market. Unconfirmed rumors then began that one or more governments or central banks were prepared to step up to buy Italian bonds, and perhaps Spanish as well. Voila! The 150 points were recovered before the opening.
Once open, the market drifted down early in the day until the announcement of the most recent FOMC meeting minutes. The mere suggestion that QE3 was not completely off the table produced an 80-point bounce in the Dow in about 20 minutes.
Demonstrating that the same story can play more than once, Fed Chairman Bernanke’s testimony before the House on Wednesday was largely responsible for a 160-point Dow rally. While he said virtually nothing that had not already appeared in the earlier FOMC minutes, his actual statement that QE3 was still a possibility set off a rapid rally just after the words left his mouth.
In his Thursday testimony before the Senate, Chairman Bernanke clarified his message. While not taking QE3 off the table, he enumerated the dire economic circumstances that might necessitate its implementation. His qualifying statements turned a morning rally into a loss for the day, a 160-point turnaround.
These moves are not coming from investors but rather from short-term traders, many not even human. Algorithms directing order flow can be keyed to such factors as Bernanke’s tone regarding the potential for further stimulus. Clearly the trading community’s knee-jerk response is still positive when further rescue money is proposed. At some point, however, investors might begin to focus on the negative underlying fundamentals that could lead to an additional bailout. QE2 was implemented when the initial quantitative easing was originally scheduled to be withdrawn. Fundamentals were so weak, however, that the withdrawal had to be swapped for a second round of stimulus. QE1 failed to accomplish its objective. Imagine how weak fundamentals would have to be for the Federal Reserve to take a third similar step, adding even further to a debt level that increasingly endangers the financial survival of future generations. What confidence could investors and citizens in general have in the success of a rescue program that had failed twice before? As those concerns move to the forefront, traders might hesitate to push the “Buy” button when the next rescue is proposed.