Continental Capital Advisors, LLC June 18, 2010

Quantitative Easing Does Not Guarantee Higher Stock Prices

The US economy and much of the global economy continues to be in a post-bubble, debt
deleveraging process. M3, the broadest measure of money supply, demonstrates that deleveraging
has re-emerged as a key threat to economic growth. As measured by Shadow Statistics, M3 declined
5.9% this year versus last year for the month of May - the worst contraction since 1934 during the
Great Depression. Despite the ominous trend in M3, many investors are holding risk assets, such as
stocks and bonds, with the false hope of a self-sustaining economic recovery and/or the assumption
that the Federal Reserve will bail them out (via quantitative easing) should equity markets fall.

The investment mantra Dont Fight The Fed was echoed loudly on Wall Street from August 2007
through February 2009. This was bad advice even though the Federal Reserve continually cut
interest rates and launched numerous special lending facilities. Not surprisingly, faith in the Federal
Reserve has since returned because of the 80% rally in the S&P 500 from March 2009 through April
2010, which coincided with the start of the Federal Reserves quantitative easing program.
However, quantitative easing may not have produced the massive rally in risk assets, but rather the
rally resulted from severely oversold market conditions, much like the rally from November 1929
through April 1930.

Regardless of what generated the rally in risk assets, investors should not be comforted by the
Federal Reserves ability to reinitiate quantitative easing. For one, if the Federal Reserve has to
increase its asset purchases, the stock market and the economy will have already retreated
meaningfully. Secondly, Figure 1 shows that even with significant asset purchases by the Bank of
Japan from 1997 (earliest data available) through 2006 the Nikkei 225 index failed to respond
(Figure 2). Japanese stocks instead followed the path of the global economy and global stock
markets. Investors should note that the Japanese stock market is now 50% lower than it was in 1997
despite a more than doubling of the Bank of Japans balance sheet.

Figure 1. Bank Of Japans Assets (billions of yen; July 1997 June 2010)

180,000

160,000

140,000

120,000

100,000

80,000

60,000

40,000

20,000

0
97

98

99

00

01

02

03

04

05

06

07

08

09

10
19

19

19

20

20

20

20

20

20

20

20

20

20

20

Sources: Bank of Japan, Continental Capital Advisors

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Continental Capital Advisors, LLC June 18, 2010

Figure 2. Nikkei 225 (July 1997-June 2010)

25,000

20,000

15,000

10,000

5,000

0
97

98

99

00

01

02

03

04

05

06

07

08

09
19

19

19

20

20

20

20

20

20

20

20

20

20
Sources: Yahoo! Finance, Continental Capital Advisors

Figure 3. S&P 500 (July 1997-June 2010)

1800

1600

1400

1200

1000

800

600

400

200

0
97

98

99

00

01

02

03

04

05

06

07

08

09
19

19

19

20

20

20

20

20

20

20

20

20

20

Sources: Yahoo! Finance, Continental Capital Advisors

The only discernable difference between the performance of the Nikkei 225 and the S&P 500 is the
period from 1997 through 1999 when the Japanese stock market fell while the S&P 500 rose.
Despite significant quantitative easing by the Bank of Japan, the stock market was unable to
overcome the negative forces of high equity valuations, economic weakness and deflation. This
historical example of ineffective quantitative easing is being ignored by investors in US assets.
Furthermore, the current deleveraging process is global in scope and impacts both the private and
public sector. As a result, investing in risk assets on the basis that the Federal Reserve will print
money is likely to be even more costly than it has been for investors buying Japanese equities.

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Continental Capital Advisors, LLC June 18, 2010

Daniel Aaronson daaronson@continentalca.com

Lee Markowitz, CFA lmarkowitz@continentalca.com
http://www.continentalca.com

Disclaimer: The above is a matter of opinion and is not intended as investment advice. Comments within the text
should not be construed as specific recommendations to buy or sell securities. Individuals should consult with their
broker and personal financial advisors before engaging in any trading activities. Certain statements included herein
may constitute "forward-looking statements" within the meaning of certain securities legislative measures. Such
forward-looking statements involve known and unknown risks, uncertainties and other factors that may cause the
actual results, performance or achievements of the above mentioned companies, and / or industry results, to be
materially different from any future results, performance or achievements expressed or implied by such forward-looking
statements. Any action taken as a result of reading this is solely the responsibility of the reader.

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