The Fed’s latest QE2 move has renewed the controversy over the effectiveness of monetary policy in an environment characterized by excess capacity, de-leveraging, and zero interest rates – also known as the Keynesian Liquidity Trap. Under such circumstances, it is unclear whether adding liquidity to the financial system can successfully stimulate demand and promote growth. What is indisputable, however, is that for the Fed to succeed it must re-kindle animal spirits a la Keynes to invest in the future - led by investment in globally competitive industries rather than domestic over-consumption. Such periods, like the 1990’s as opposed to the 2000’s, have seen growth stocks (with high earnings growth and P/E’s) beating value stocks (with low earnings growth and P/E’s) accompanied by real rates exceeding 3% (indicating high returns on capital).
Look for growth stocks (e.g. high tech) to beat value stocks (e.g., financials) and higher real rates further down the road to confirm that the Fed’s policy has worked in promoting sustainable economic growth. (See our previous feature – Cyclical vs. Secular Forces).
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