Today's Intraday Market Rally Was An Overreaction

by Ryan Snefsky

At one point, the Dow Jones Industrial Average (DJII) was up over 160 points today on renewed hopes for a QE3 spawned by comments from Fed Chairman Ben Bernanke. However, the index gave up most of its earlier gains to close up only 44.73 points at the end of the trading day.

The fact that the market gave away much of its rally today should not be very much of a surprise. In my opinion, I think the odds of a QE3 happening sooner went up slightly today, but not nearly as much as many traders think.

Bernanke has suggested before that he would be more willing to explore the idea of a QE3 if unemployment continues to get worse and if the market continues to experience "deflationary" pressures. June's employment data was pretty ugly. However, deflationary pressures are something of a different story.

The mere talk of a QE3 caused the value of the dollar to decrease against other currencies today. When the value of the dollar decreases, commodities become more expensive. Rising commodity prices are inflationary, rather than deflationary. So as Bernanke continues to suggest the possibility of a QE3, the market's reaction effectively decreases the likelihood that it will occur.

Additionally, the Fed would have to weigh the negative effects a QE3 would have on U.S. consumers. One of the commodities that would increase in price with the implementation of a QE3 is oil, which would ultimately put upward pressure on the price of gasoline. If unemployment continues to get worse and the price of gasoline increases substantially for the consumer, the result could weigh heavily on the economy.

Finally, the increased possibility of a QE3 happening sooner, rather than later, also would suggest that the economy is in a much worse position than the Fed expressed in June. When we add the possibility of a more unstable current economic environment to the debt ceiling issue and serious credit challenges in Europe, this doesn't create an environment that justifies much higher equity prices.

Today's intraday market rally of more than 160 points for the DJII was an overreaction to today's news and was not justified. For the market to go up substantially from here, I think it's going to take more than QE3 speculation. It's going to take real improvements in economic outlooks for the second half of the year coming from America's CEOs when they report quarterly earnings across the next month.