Is Fed Money Fake? Investors Make It Real

Quantitative easing does seem to boost markets (at least for a bit).

By + More

For stocks, sometimes it's just about the money. On September 13, the market rallied as if investors were completely stunned when the Federal Reserve announced its QE3 policy move—which made the hotly anticipated statement look like the best-kept secret since Apple's iPhone 5.

Why the big rally for something that was expected for months? The reason is that this time, the stock market was waiting for the "check" to arrive before spending it. The stock market nearly always moves on expectations—anticipated earnings and dividends, and projected returns. But Fed actions are different.

[See Wall Street Loves Alternative Investments. Should You?]

To be sure, there is anticipation, but when the Fed does finally have its "show me the money" moment, it nearly always causes a buying burst. Often, stocks slide back afterward. But for a number of reasons, it's possible that this one will be different, in part because the Fed promised to keep stimulating the economy "for a considerable time after the economy strengthens."

Why the Fed eased. The economy, already mired in slow growth, began to sag further in April as job growth slowed by 50 percent from the prior month. Markets have been expecting a Fed move since then.

With Congress sitting on its hands in an election season, there was little chance of a fiscal stimulus in the form of a jobs or public-works program. That made a Fed monetary boost all but certain.

Stock market investors reacted immediately when Chairman Ben Bernanke announced the policy move. The Dow Jones Industrial Average jumped 201 points, or 1.5 percent, in its biggest one-day rise since June.

"It went up like a rocket," says Mark Germain, chief executive officer of Beacon Wealth Management. "It can keep going up. It will probably inch up from now to the election. This [Fed move] gives some staying power to a market that was built on vapors. What the Fed announced was a little better than what people thought."

So what to make of the Fed's announcement that caused the biggest one-day gain in months? It could simply be that it matched the day the Fed turned on the cash spigot, as it coincided with the Fed's push to put real money into the financial markets, even if critics say all the government is doing is printing more cash or creating an "artificial" economy.

Or investors may have cheered the fact that the Fed's New York trading desk will now be in the market buying up securities, $40 billion each month in an ongoing process. It doesn't buy stocks, but the money the Fed pays to dealers for long-term government-backed securities quickly goes into other investments.

"Money matters," said a congressional monetary analyst, Marc Labonte, in a 2008 report explaining the big impact of monetary policy on the economy. Based on "the standard open economy," the report said, "monetary policy is more powerful than fiscal policy in influencing GDP growth and employment."

[See Brawling Politicians: Bad for Your Portfolio?]

Looking for a broader impact. Market gains could be short-lived, as markets digest this sizeable rally in the face of a variety of uncertain events in the near future (U.S. elections and European debt wrangling, to name just two). Also, a downturn in earnings could also pull stocks lower again, Germain says. Surprisingly weak results from Federal Express just five days after the Fed action deflated some of the enthusiasm over the Fed's move. FedEx is seen as a ubiquitous participant in the global economy, whose revenue reflects the activities of thousands of companies.

"When all you do is put cash out there and take out securities, it does increase cash," says Germain. "But unless people are creating real demand, though, people are not going to hire and the economy will not have real growth."

Much of the impact of this and other Fed moves stems from its ability to buy time for the rest of the economy to continue its recovery. The rise of stocks alone can sometimes have a wealth effect, and the stock market's recent advance to post-crash highs could do that. There will also be a positive short-term impact on some $5 trillion in sales rung up by U.S. companies abroad, the amount estimated by the U.S. Chamber of Commerce.