Is the Fed Driving the Dow Higher?

Blue-chip stocks are marginally lower this afternoon despite a general absence of economic news. With roughly an hour left in the trading session, the Dow Jones Industrial Average (DJINDICES: ^DJI  ) is off by 5 points, or 0.04%.

Shares of older, industrial companies like Alcoa (NYSE: AA  ) and Caterpillar (NYSE: CAT  ) are leading the Dow lower this afternoon. One reason could be speculation that the Federal Reserve will taper its monthly bond purchases by the end of the year. According to The Wall Street Journal, "more than half of the 49 economists who participated in the latest ... forecasting survey" believe that it will do so.

At present, the central bank is forking out $85 billion each month for treasuries and agency mortgage-backed securities. And it's this constant stream of liquidity that many believe is fueling the ongoing rally in stocks. Just recently, the Dow passed the 15,000-point threshold for the first time ever.

The concern here is twofold. On the one hand, retirees and savers are upset at the impact the Fed's policies have had on interest rates. Yielding only 1.9%, the 10-year treasury is providing less than half as much income as it did prior to the financial crisis. Beyond this, traders are increasingly agitated that the boost to equity prices hasn't allowed the stock market to "clear" -- that is, fall to its market-driven level (this is assuming, of course, that there is such a thing).

On the other hand, and to the latter point, if the central bank were to withdraw support from its easy money policy, there seems to be little question that stocks, as well as the economy, would contract. This is the reason negative news on the jobs front isn't necessarily followed by a down market. And this is particularly true for companies that deal in commodities (the prices of which increase as a result) either directly or indirectly as Alcoa and Caterpillar do -- the latter principally through sales of mining equipment.

This divide has naturally made its way to the front pages. In addition to the column in the Journal, Yahoo!'s Daily Ticker published an article this morning citing a number of high-profile economists and fund managers debating the point. Stanley Druckenmiller says that quantitative easing is "totally outrageous and inappropriate." Meanwhile, Paul Krugman mused, "I do wonder in this case whether there's extra hatred of Bernanke because he keeps proving them wrong: they keep predicting terrible things from QE, runaway inflation, and all that, and instead the bearded academic stuff keeps turning out right."

At the end of the day, for the individual investor, a precise answer to this question will remain elusive until it's too late to do anything about it. And it's for this reason that we at The Motley Fool encourage people to predicate investment decisions on the fundamentals of the stocks they own as opposed to the daily or monthly whims of the market, be the whims fueled by monetary policy or something else.

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