One of the oldest adages in the stock market is "Don't fight the Fed." Until the economy starts creating more jobs, the Fed is going to be fighting to keep interest rates low - and that's good for stocks.
Today's job reports showed only 96,000 new jobs created in August, vs. 125,000 estimated by economists. The unemployment rate fell to 8.1%, but that's not enough for the Fed to back off from its policy of ultra-low rates and easy money.
"I think the Fed will go ahead and do some kind of QE3 here - small steps, meeting by meeting," says John Silvia, chief economist for Wells Fargo. "The Fed has said they are disappointed in the pace of job growth, and this just solidifies that."
QE3 stands for a third round of quantitative easing, a Fed technique to keep interest rates low by buying bonds with newly created money.
The Fed's dual mandate is to keep the economy moving and to keep inflation in check. By keeping interest rates low, the Fed is allowing companies and consumers to refinance their debts, giving them extra money to spend. That's good for stocks.
But keeping rates low is good for stocks in another way: It makes stocks look more attractive in comparison with bonds.
The 10-year Treasury note now yields just 1.67%. Money market funds yield a miserly 0.03% on average. Since Fed Chairman Ben Bernanke announced the second round of quantitative easing on Aug. 27, 2010, the broad Wilshire 5000 stock index has gained 36.5%, or $4.6 trillion.
Further quantitative easing will also likely propel gold higher, as investors fret about the Fed fueling inflation.
The Fed's job isn't to prop up the stock market. But the Fed wouldn't mind seeing a stock rally, either. Investors have seen their retirement accounts slashed by two massive bear markets in the past 12 years. If their balances rise, they'll feel more prosperous — and more inclined to spend. And that, too, is good for stocks
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