Big Money Is Buying as Fed Favors Stocks

12/01/2010 2:36 pm EST

Focus: MARKETS

Kelley Wright

Managing Editor, Investment Quality Trends

Kelley Wright, managing editor of Investment Quality Trends, expects a year-end equity rally based on the bullish bets of institutional investors.

In the 1989 movie “Field of Dreams,” an Iowa corn farmer hears a voice say, “Build it and they will come.” The farmer interprets this voice as a command to build a baseball diamond in his fields; he does, and Shoeless Joe Jackson and the rest of the Chicago Black Sox come. Later in the movie, one of the characters tells the farmer, “Oh they will come Ray; they most certainly will come.” In the final scene of the movie, a line of cars as far as the eye could see are shown driving toward the field.

The implication is that where there is supply, in this instance the ability to see baseball played as it was in a bygone era, the demand, baseball fans, would be compelled to drive from all over to see (consume) this phenomenon.

On Nov. 3, the Fed plowed ahead with their version of the field of dreams: Shove enough liquidity into the system [via bond purchases] and it will create demand. Build it and they will come, indeed.

We’re Turning Japanese
Whether the Fed’s actions prove to be successful or not remains to be seen; history, however, is not on their side.

In the same year “Field of Dreams” was released, Japan’s Nikkei stock index reached an all-time high near 39,000. Shortly thereafter the bubble burst and Japan morphed from a nation of rabid consumers to virtual skinflints; demand was simply crushed.

In an effort to combat this bunker mentality, the Bank of Japan initiated a policy of what we now know affectionately as quantitative easing; eventually reducing interest rates to virtually zero. So how did that work out for Japan? Some 21 years later, the Nikkei index is trading roughly around the 9,900 range. The question then, which is just screaming to be asked: Can monetary policy create consumer demand and restore growth to a mature economy?

Where the Fed has been successful in creating demand is in the stock market. With interest rates on fixed-income instruments containing any attributes of quality at barely discernable levels, the stock market has become the only game in town; the commodity and futures markets being the exceptions, of course.

My instinct is that after a brief correction we will see another push to the upside. In fact, it would not surprise me in the least for the market advance to extend into the new year.

Institutions Smell a Rally
The spread between institutional buying and selling is fairly pronounced. This is to say that institutions are buying much more than they are selling. This is significant because institutional investors are the 800 lb. gorillas in the markets, representing over 50% of the trading volume on any given day. So knowing what institutional investors are doing is important. Generally speaking, it’s not too smart to get in their way.

Of course all of this can change in the bat of an eye, but as long as there is a liquidity inflow and institutions continue to buy, this secondary trend should maintain an upward trajectory. At this stage in the market cycle the primary beneficiaries of this accumulation should be predominantly in our wheelhouse: high-quality and good value.

Build it and they will come? We’ll most definitely see.

[Wright isn’t the only one to doubt the long-term wisdom of the Fed’s bond purchases while stressing the short-term upside for stocks. Axel Merk recently offered a similar prognosis. In contrast, John Mauldin has argued that the share buyers piling on “will get their heads handed to them” if the policy ultimately fails.—Editor]   

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