Markets anticipate the QE2 ‘Lifeboat Party’

Index Oct10.pngWarren Buffett, the legendary US investor once cautioned that “over time, markets will do extraordinary, even bizarre, things.”
We are certainly living through such times today.
In August, the US S&P 500 Index fell 5%, as investors worried about the end of stimulus packages, and the return of banking problems in Europe. The IeC Boom/Gloom Index mirrored this fall, sinking back to its post October 2008 lows.
These fears came true came true last month, as the weaker European economies faced record levels of interest rate spreads; Ireland warned the rescue of Allied Irish Bank might cost a third of GDP; and the US Federal Reserve said it might resume Quantitative Easing (QE2), due to its worries about the US economy.
In response, the US S&P 500 rallied 9%, with the Boom/Gloom Index (above) tracking it once again as sentiment turned bullish.
Extraordinary, even bizarre“, might seem a good description of events.
The issue is our old friend, liquidity. As the SEC report into May’s ‘Flash Crash’ shows, the high-speed traders who now dominate financial markets couldn’t care less about underlying economic reality. To them, as BofA Merrill Lynch commented, “QE2 = the Bernanke Lifeboat for the equity market“. All the boys with the big computers care about is that the US Federal Reserve might soon sponsor another tidal wave of liquidity.
They expect this to trigger renewed fears about the potential for rising inflation. In turn, they hope this will drive the value of the US$ lower, and cause renewed buying of commodities such as crude oil. Its the perfect opportunity for them to max out on bonuses in time for Xmas.
But once the party has ended, and the computers have been shut down for the night, it will be the real world of the chemical industry that will have to pick up the pieces.

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