Market Having 2nd Thoughts About QE3?

Optimists likely call it a consolidation phase, but the reality is that the market appears to be having second thoughts about the QE3-inspired gains. The gains started in the summer and pushed stocks to their highest level after the announcement.

The market pause of the last few trading sessions may just be a sign of tentativeness and nervousness ahead of next week’s key economic data and the start of the third quarter reporting season. But the tentativeness is completely justified. The return today of Spain and Eurozone-centric concerns will add to the nervousness.

I have been skeptical of the sustainability of Fed-inspired gains for awhile and continue to believe that Bernanke’s open-ended bond purchase program is largely irrelevant to the broader issues facing the U.S. economy. Lack of economic growth, both in the U.S. as well as worldwide, is steadily emerging as a far bigger drag on corporate profitability than many in the market realize at this stage. We have seen this show up in earnings projections for the third quarter, which are expected to be down 3.4% from the same period last year.

But expectations remain high for the fourth quarter and beyond in the hope that the economic growth issues in the U.S. and China will prove to be temporary. It is useful to be somewhat skeptical of that view at this stage and view the recent profit warnings from companies like FedEx (FDX - Analyst Report), Intel (INTC - Analyst Report) and Norfolk Southern (NSC - Analyst Report) as a sign of things to come.

My sense is that the third quarter reporting season will provide this market a reality check, helping bring down earnings and overall growth expectations for the out quarters. This may not trigger a precipitous market sell-off, but it will most likely cause the market to give back some, if not all, of its recent gains.