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Where Have We Seen This Market Before?

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Stock market history is repeating itself under quantitative easing.

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The stock market rally since the beginning of the year is seemingly relentless. Regardless of whether the market-related news is good or bad, stocks seem to fight their way higher day after day. This should not be mistaken as a signal for optimism about the US economic outlook, however. Instead, the recent rally is purely the byproduct of aggressive monetary stimulus from the US Federal Reserve. And recent history has shown that such rallies do not necessarily continue forever.

At the beginning of the year, the Fed added the purchase of US Treasuries to its latest QE3 stimulus program. It has been no coincidence that the market has subsequently rallied almost without interruption ever since, as the stimulus program effectively amounts to the Fed dropping off a $4.5 billion bag of cash on the doorsteps of US banks each and every trading day. Thus far, this cash has leaked its way into the stock market. But such preferences can change at a moment's notice.

(See also: Quantitative Easing: The Greatest Con Ever Sold)

A look back at the Fed's previous balance sheet expanding monetary stimulus program highlights this point. In late 2010, the Fed launched QE2, which also included the outright purchase of US Treasuries. And not long after the launch of QE2, stocks also entered into a seemingly relentless rally that lasted two and a half months. What ended the rally back in mid February 2011? The outbreak of the civil war in Libya is often cited as the reason, but a view across asset classes suggests it was simply a rotation out of stocks and into other asset classes. In other words, market preferences changed, as stocks ground sideways for the remainder of QE2 while other categories such as precious metals, including gold and silver as well as long-term Treasury bonds, soared.



Today, stocks under QE3 are following a strikingly similar path experienced under QE2. Looking ahead, if stocks today were to happen to continue this pattern going forward, it would imply the current rally on the S&P 500 Index (INDEXSP:.INX) would have another two weeks and +1.8% to the upside before hitting a comparable peak. Exactly where on the S&P 500 would this peak occur? At 1579, which just so happens to be effectively at the previous stock market peak first reached in March 2000 and revisited in October 2007. Given the fact that the stock market has approached this level twice over the last 13 years and subsequently went on to decline by roughly half, this level represents major resistance.

None of this means that stocks will fail this time around. After all, it's often said that the third time's the charm. So perhaps stocks will simply blow through this resistance and break out to new highs. But given the widespread risks that continue to overhang the global economy and its financial markets, it is worthwhile to pay close attention to markets at these levels. And exploring what other opportunities may be currently presenting themselves beyond the stock market would be at a minimum prudent. It will be interesting to see how it all plays out.

(See also: 12 Cognitive Biases That Endanger Investors)
Positions in MDY, CEF, GTU and BAB.
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