Stocks Are Falling...

Fear not... The correction is unlikely to be deep. Indicators are pointing that this is a buying opportunity. Markets should rally on until June of 2011 when QE 2 ends. After that, a big correction of around 20% may occur. Whether stocks will move higher in the second half of 2011 will depend on whether inflation is under control. If inflation is benign, valuations low, growth in tact and yield curve steep, we may have a bull in 4Q2011 after a steep correction in 3Q2011.

It is also interesting to note that after news of Egypt's turmoil came out, stocks corrected steeply but commodity futures rallied. It shows that in political uncertainty, people flock to hard assets. Read on...

Bond Flows Have Turned Negative


Investors seem to be realizing that higher interest rates are not good for their bond investments. As we wrote in mid November in our article, Interest Rates On The Rise, higher interest rates translates into a declining value in the price of an investor's bonds. Recent mutual fund flow data shows investors have been placing less of their funds into bond mutual funds. The below chart shows the trend in the flow of funds into bond and equity funds through mid November. Bond inflows had essentially dried up.

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From The Blog of HORAN Capital Advisors


The below table from the Investment Company Institute shows that bond flows have now turned negative with a majority of the outflow occurring in municipal bond funds.

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From The Blog of HORAN Capital Advisors


This recent action reverses a long term trend of investors pouring investment dollars into fixed funds since 2006 and detailed by the red line in the below chart.

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If QEII Inflates Risky Assets, What Will Be When It Ends?

On August 27th of last year, Ben Bernanke gave a speech at the Jackson Hole, WY meeting that signaled the beginning of the Fed's second round of quantitative easing. Since the speech, the stock market has responded favorably for long equity investors.

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From The Blog of HORAN Capital Advisors

Source: Viewpoint-Fidelity

Not only have equity prices reacted favorably to the Fed Put, but many commodity assets have responded as well as noted in our post, More Evidence Of Inflation In The System.

I do not recall the source of the below chart; however, during the Fed's first round of quantitative easing, the market experienced strong upward returns. The market's positive return during QE1 could be viewed as a coincidence; however, the quantitative easing dollars need to flow somewhere, and risky asset prices seem to be the beneficiary. This has been a stated desire by the Fed as well.

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From The Blog of HORAN Capital Advisors

One question that comes to mind is what will be the market's reaction once QE2 comes to an end in June. One date that might be of importance is the Fed's Humphrey-Hawkins testimony before Congress in February. Given the change in the control of the House to the Republican side and their prior opposition to quantitative easing, might the Fed step up the QE program and have it end around the time of the Humphrey Hawkins testimony? Ron Paul, who has not displayed much favor for the Federal Reserve, has been named Chairman of the Subcommittee on Domestic Monetary Policy and Technology, the committee charged with overseeing the Federal Reserve.