QE3 or August 2007 again

Bernanke´s trick seems to be working again. Markets went into a significant rally last week following the FED´s decision to “expand its holdings of long-term securities with open-ended purchases of $40 billion of mortgage debt a month in a third round of quantitative easing”. The stated objective is to foster employment and growth but the real motive might be more mundane – to sustain the current bull market in real estate securities.

Back in August 2007 Bernanke also attempted to stop the impending market crash. It worked for a few months (see the S&P 500 chart below) but the inevitable correction came back with a vengeance, causing the second ever largest market crash in 2008.

Now, like then, there is a very large divergence between the price of financial assets and their underlying real assets. The divergence between a popular real estate ETF (IYR) and the prices of real estate as measured by the Case-Shiller Index is well illustrated in the following chart.

As we alerted in a previous post (markets behaving badly again), since a rally in real estate prices is not foreseeable without going back to high levels of inflation you can imagine the way the correction will go.