Ben Bernanke's November speech led to a second round of equity gains. The first round came with announcement of QE2 in August. This equity rally will continue until there is a new vision on monetary policy.
From Bernanke:
“…Higher stock prices will boost consumer wealth and help increase confidence, which will also spur spending. Increased spending will lead to higher incomes and profits that, in a virtuous circle, will further support economic expansion…”
Bernanke is following a Greenspan playbook of using financial markets to gain a wealth effect. The wealth effect has not been viewed as very strong but it seems to be one of the key tenants of current monetary policy.
The stocks markets should make most investors nervous. In spite of nice gains since August, investors should be unsettled by the increases in equity prices. First, valuations look like they are high as measured by the Robert Shiller cyclically-adjusted P/E ratios. Second, there is a disconnect between central bank behavior and the robust gains in equities. Low interest rates are necessary to help fragile economies, yet if economies are fragile we should not need low rates. Low rates which help equities may not be a positive sign for long-term gains; nevertheless, as long as the Fed signals that it wants to get financial asset prices higher you have to be part of the wave.
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