Bernanke looked at the QE switch and the world shivered 24 May, 2013.

Bernanke looked at the QE switch and the world shivered 24 May, 2013.

Ben Bernanke and his FOMC members are hinting that they may slow down buying US debt.  Not turning the tap off completely but pumping less liquidity into the system.  In technical terms, this is a slowdown in quantitative easing (QE).  As the Federal Reserve (Fed) buys bonds from the market, it pays the sellers money hence pumping money to the system.  A lot of these bonds are issued by the government.  United States are practically buying back their “I Owe You” piece of paper using Greenback that they print.  The Greenback is real money that can be used to buy food and water.  If the Fed slows down their buying of debt, there is less Greenback in the system and may have a negative impact to economy.  Since the Global Financial Crisis in 2008, the US has been using QE to save the world.  The trouble banks are busy reducing their balance sheet and debt through deleveraging and sucking money out of the system.  To counter that, Bernanke has been throwing money at the market through buying bonds and debts with real money.

We saw QE3 in September 2012 that got Fed to buy USD 40 billion of bond a month and QE4 in December 2012 to increase the purchase to USD 85m a month.  These 2 QEs super charged the US stock markets to historical high.  It was mentioned in this column before that QE is like steroid.  It helps you to punch above your weight but long term usage will damage your health and its effectiveness will decrease with time.  Ben Bernanke and his team start to think now is the time to reduce dosage as US.  Dow Jones Industrial was the first to made new high in March 2013 and the boarder S&P 500 Index made new high on 28 March.  With both indices beating the 2007 peaks, it is time for Ben Bernanke to reduce dosage.

One potential outcome of slowing QE is further strengthening of US Dollar against the world currency (Euro, Sterling, Japanese Yen) and even gold.  It is a good idea to see the economy improving with less dosage of steroid.  Investors are concern that this may mean weaker earnings in companies and the next day Nikkei 225 index dropped by more than 7%.  The biggest drop since the earthquake in March 2011.  It puts a big dent to the 70% rally in a year.  Money looks for safe heaven and many people find themselves parking in USD and US Treasury. 

There is another angle to explain the strength of USD.  If you put yourself into the shoes of some big hedge fund managers, especially the global macro funds.  These are the big picture guys and they use the most liquid instruments to express their view.  In the currency world, there are a few currencies that one can move a few billions of dollars without waking up anybody.  These are USD, EUR, JPY and perhaps GBP.  To a lesser extent, gold as well.  Most funds have short EUR for years already on the back of the Euro crisis.  However, this is a very obvious trade and everyone does it.  This is what people called over crowded trade.  The Euro crisis has turned into an on-going concern.  Most hedge funds needs big and sharp move to make a killing.  Remember when Soros attached GBP in 1992.  The attack in GBP in the first quarter of this year sent GBP from USD 1.63 to USD 1.49 on the back of UK credit rating downgrade.  The big winnings come from the JPY move.  It was JPY 80 to USD 1 in November 2012 and in May 2013, JPY 103 to USD 1.  Thanks to Abenomics.  In May, gold was the victim and it dropped from USD 1474 to USD 1360.  So far, every attack is betting on USD strengthening against the other side.  It looks like the hedge fund managers have completed a round.

In the stock market, institutional money has also gone to developed markets like US, UK, Germany and Japan.  Germany, despite being in the heart of Euro zone, its stock market is also making new high.   This reflects two things.  Firstly, hot money has limited choice with bond yielding so low.  Secondly, institutional investors should be having the biggest smile since 2007 with both bond market and stock market rallying.

It does sound too good to be true.  Here comes the big question.  Is it time to take profit in the stock market?  Remember Warren Buffet once said, “We simply attempt to be fearful when others are greedy and to be greedy only when others are fearful”.  If everyone around is greedily buying stock, it’s time to get out.  Oppositely, if people are not convinced or neglecting the market, the bull train may have a few more stops to go.