Although by some measures stocks are not cheap, we think they will keep going up on a rising tide of global quantitative easing.
Prior to Bernanke’s testimony to Congress yesterday, treasuries had taken a hit and the rally in equities had stalled amid speculation that QE could be tapered later this year.
As we’ve said before, rumours of the death of QE were greatly exaggerated. With inflation expectations in a downward trend and actual inflation falling, the debate at the Fed is shifting toward the possible need for more, not less QE.
It comes down to a trade-off between the wealth-effect from further gains in equities, which helps in the fight against deflation, and the risk of fuelling a bubble in asset prices.
Our firm belief has been that Bernanke would rather fight deflation, which is much harder to deal with than a burst bubble (think of the Great Depression and Japan’s two lost decades) – this seems to be confirmed by yesterday’s testimony.
The latest US inflation data will only have heightened this vigilance – headline CPI slowed more than expected to 1.1% from 1.5% in the latest figures.
Continued QE from the Fed supports the case for a sustained equity rally, particularly when combined with aggressive QE in Japan and potential for the European Central Bank and Bank of England to add to this rising tide.
Meanwhile treasury yields have jumped (prices have slid), which suggests investors are betting Bernanke will win the battle against deflation.
