The stock market swung wildly this past week, with the final result  the S&P 500 down 3.1%, and the Nasdaq 100 down 3.9%.  Everybody knows a major reason why:  The Federal Reserve is winding down its aggressive monetary stimulus, and now the question is will they increase interest rates, and if so, how soon?  QE3 is ending, and the unprecedented monetary stimulus (~$1.6T added to the Fed’s balance sheet, with half in mortgage backed securities and the other half in treasuries) will stop.  No serious economist or market observer doubts that the Fed’s accommodative policy has been at least a large part of the rise in the stock market, albeit debatable how much of the rise is due to easy money.    As the Fed has promised to curtail its monetary profligacy, it was expected that the European Central Bank would pick up the pace, but now the anti-inflationary Germans are protesting, as reported in the FT:

But a much hoped for programme of quantitative easing by the ECB appeared to receive a setback as Wolfgang Schäuble, Germany’s finance minister, essentially described it as both unnecessary and fraught with risks. Bundesbank president Jens Weidmann struck a similar tone a few days earlier.

But now QE is ending, and if the stock market is in a bubble and only as high as it is because of Fed stimulus, are we due for a correction?  I’m not alone in thinking this is highly probable at some point, and likely soon.  After all, the S&P500 has over tripled since the crash in 2008/9, and its up ~30% since QE3 began in Sep 2012.   While stock market corrections (a 10% drop in stock prices) normally occur ~ every 18 months, its been 3 years since the last one (Oct 2011).  The dollar is still up dramatically the last several weeks, with Treasury yields  and commodity prices down and spreads between risky assets and treasuries rising.  All of this is indicative of stress in the markets, and the potential of a significant correction as QE3 winds down this month.

With foreign policy a disaster, unemployment/underemployment a continuing concern, and Ebola a scare, what is likely to happen in November if we see the stock market down 20-50%?  Ouch.  Not a good season to be the incumbent political party.  What the Fed gave Mr. Obama before the 2012 election with QE3 they are now taking away.  Hang on for the ride…