The hope of a QE3-led recovery has sent the equity markets to 4-year highs.  However, the bar is set pretty high now as the market is likely priced for perfection.  If the new round of Fed easing fails to jumpstart the economy, the stock market could certainly react accordingly (to the downside, that is).  We remain skeptical that QE3 will be the anodyne that relieves the pain of our past and we recommend that investors remain cautious.  High debt levels, stagnant job growth, and low home values are three major headwinds that we continue to face.

Let's not forget that we still have a major debt problem on our hands. Despite diminishing returns from additional debt, policymakers and central bankers continue to leverage the existing playbook for dealing with our debt crisis. Over the last 70 years, each crisis has brought greater stimulus. Current debt levels are simply unsustainable.  As a matter of fact, S&P warned yesterday that they will be forced to downgrade our credit rating again if we don't get our debt to GDP ratio under control.

It's no secret that job growth is critical for a sustainable economic recovery.  However, employment growth continues to hover below the magic 200,000 number that signals a strong job market.  As shown in the chart above, monthly job growth has been below 200,000 for six consecutive months now.  Payroll growth below this level has historically been negative for stocks.  In fact, the last time payroll growth was below 200,000 for six consecutive months (May 2011 - Oct. 2011), the S&P 500 declined almost 20% from peak to trough.

As a side note, Alan Abelson pointed out in his Barron's column this week that more people went on the food-stamp program in August (173,000) than those who managed to find a new job (96,000).  That certainly doesn't sound like a recovery...

The housing market is still relatively weak in the U.S.  As shown in the chart above, while home prices have stabilized recently, prices are barely back to early 2003 levels.  Almost 25% of all residential properties with a mortgage are still "underwater" (i.e., the borrowers owe more on their mortgages than their property is worth).  In our opinion, home prices will need to recover substantially in order for a recovery to be sustainable.