“US equity markets are flying ahead. In this environment Fuller Money advises caution and points to the danger of the end of QE. For several years the Fed has been encouraging the purchase of equities but may now be concerned about over-heating. What better way than to make noises about the end of QE?

“Apart from suppressing “excessive exuberance” why would the Fed have any motive to reduce QE?

“Inflation poses no threat and, in fact, has been falling for 15 months (see Chart below)

“Commodity prices have been trending down since early 2011

“The US Government shows no sign of fiscal responsibility and will require massive Fed purchases of Treasuries for months to come.

“Bond yields have been gently trending up since August 2012. Reduced purchases by the Fed would see rates accelerate upwards to damage the fragile recovery

“While much publicity has been given to the imminent end of QE, US investment adviser Robert M Williams of St Andrews Investments has noted that, “In March we heard comments from Fed Presidents Eric Rosengren and Narayana Kocherlakota calling for QE well into 2014 while Chicago Fed President Richard Evens thought the Fed needed to do more. Then in April the St. Louis Fed President James Bullard came out on a number of occasions saying inflationary pressures may be growing too weakly and if they soften further, the central bank may have to boost its asset buying to bring price pressures back up to more desirable levels. They all share one thing in common, they are worried about a decline in the rate of inflation as seen in this chart:

“Hopefully, the Fed will achieve its aim of slowing the equity advance without causing any significant correction.”

Eoin Treacy's view Thank you for this thought provoking email. Fullermoney's view is that the Fed is not about to end QE. The possibility that they will reduce the amount of additional liquidity they are adding has increased but will be tailored to events. There is little doubt that Wall Street is currently enjoying something of a sweet spot. Economic indicators are improving at a moderate pace while the liquidity that has helped fuel a substantial rally in stocks over the last four years continues to expand. With Japan's devaluation of the Yen, the conditions for a positive carry ensure that there is probably even more liquidity available at present than many had expected.

However, at Fullermoney we try not to rationalise the price action. As overextensions relative to a trend mean such as the 200-day MA increase, ever more good news is being reflected in the price. The good news needs to keep coming in order to sustain momentum. At the Contrary Opinion Forum last October when I opined that the S&P 500 could exceed 1600, it was considered a rather maverick idea. At the time everyone was worried about the fiscal cliff and the imminence of a recession. Fast forward and there are a lot more people talking about the genesis of a new secular bull market. Fullermoney's view is that this will not occur until after the end of QE. The question I ask myself is “If you are not going to become cautious when prices are more overextended relative to the trend mean than at any time in the course of the bull market then when do you become cautious?

The S&P 500 continues to trend persistently higher. The portion of the advance from the November low has been punctuated by three reactions of between 40 and 60 points, posted one above another to form a consistent move. Therefore a sustained move below 1600 would represent a clear inconsistency because it would be a larger reaction and would dip back into the underlying range. Such a move would probably signal mean reversion is underway. In the meantime the benefit of the doubt can continue to be given the upside and positions should be sized to allow for at least a 60 point reaction.

The Russell 2000 found support in the region of 900 a month ago following a partial reversion towards its mean and is closing in on the psychological 1000 level.