To QE or not to QE, that is the question. Or at least it is the question that seems to matter most to the markets right now. The release of the FOMC meeting minutes last week squashed for a day or two any expectations of further monetary machinations as they revealed a Fed clearly on hold. The jobs report released Friday while the market was closed will certainly revive the expectations come tomorrow morning. The report of 120,000 new jobs created over the last month was well below expectations. I doubt it will be enough to convince Bernanke that more QE is required but that won’t stop the pundits and traders from speculating about when the next round will begin. With all other policy options sidelined until well after the election, QE is about the only arrow in the economic policy quiver.

The fact that it hasn’t been a particularly effective economic policy doesn’t seem to matter much to markets. QE is nothing more than inflation by another name and it has worked wonders on nominal asset values but one would be hard pressed to say the same about the economy as a whole. Whatever recovery we’ve had since the crisis is more a testament to the natural resilience of the US economy than an endorsement of QE as a policy. If the stock market is a reflection of the economy – and I think it is – then its performance since QE began leaves a lot to be desired. When measured against real assets such as gold and oil, stocks are worth less now than when QE started. For leveraged speculators with a knack for anticipating Fed policy, QE has been a boon. For everyone else it has, at best, only kept things from getting worse. At worst, for those at the bottom of the economic totem pole, it has been a disaster of stagnant wages, continued unemployment and rising prices.

It should be noted that stocks’ poor performance relative to gold and other hard assets is not a new phenomenon. That started way back in 2001 and it will not change until policy changes in a way that makes it more attractive to invest in productive assets than non productive ones. The only way for monetary policy to induce that response is by stabilizing the value of the dollar and even then, it would likely require better fiscal policy to seal the deal. If the Fed stops buying Treasuries while the government continues to run massive deficits, interest rates seem likely to rise, which in our highly indebted economy is not likely to be good for growth. The proper policy response would be to rapidly contract the deficits while giving the Fed leeway to maintain a constant value for the dollar. That might, ironically, involve even more QE since ending the deficits should cause the value of the dollar to rise.

Since none of that appears to be in the offing anytime soon, the markets will continue to be captive to the actions of the Fed. If the minutes of the FOMC meeting are to be believed, further deterioration in the economic data will be required before Bernanke commits to more easing. While we’ve seen a cyclical recovery in auto sales that has helped the data recently, the economy remains quite weak so I feel fairly certain the data will cooperate for those hoping for QE3. What form it takes is anyone’s guess but absent a change in fiscal policy, the Fed will be forced to do something in its quest to fulfill its dual mandate. In the meantime, if the data continues to disappoint, markets will react negatively until the Fed sends a signal that it is cranking up the printing press again.

The economic data is already disappointing in relation to the heightened expectations of the market. The recent run up was built on a series of better than expected reports and that is now being reversed. The data has been consistently worse than expected over the last month and last week was no exception. In addition to the jobs report, factory orders, the ISM non-manufacturing report, construction spending and auto sales all came in less than expected. None of these are pointing to an imminent recession but growth appears to be slowing – again.

Auto sales, which as noted above have been adding to growth, were reported down 4.8% in March at 14.4 million units versus 15.1 in February. While factory orders were up in February by 1.3% that was still less than the expectation of a 1.5% rise. We’ll see if the auto sales slowdown shows up in the March report. Overall, the factory orders report was pretty solid and with unfilled orders still pending at Boeing, the auto slowdown may not matter much. The ISM manufacturing report also pointed to continued growth rising to 53.4. New orders were down slightly and export orders more but overall, again, a pretty solid report. Manufacturing continues to be the star of this less than stellar recovery.

Construction spending fell 1.1% versus expectations of a rise of 0.7%. Construction jobs also fell in the jobs report Friday so while construction may have hit bottom – I emphasize may – it isn’t exactly taking off. The only sector to gain was multifamily, up 2.0%. Mortgage applications did rise on the week so hope springs eternal.

The ISM non-manufacturing report came in at 56, a very respectable number, but again less than expected. Growth in new orders and business activity both fell. This report gives a pretty broad view of the economy and is pointing to continued growth if at a slower pace than previously expected. Jobless claims were down slightly to 357k from a revised 363k last week. Claims are a very important indicator for the market and it appears the pace of improvement has stalled. We are watching closely for a reversal in the trend.

We continue to invest very conservatively in anticipation of weaker economic data. The Fed is apparently on hold for now and that hasn’t been a good time to be long risk assets over the last few years. I don’t think this time will be any different and so, once again, we find ourselves sitting on more cash than we’d like. I suspect it will be better than the alternative for the foreseeable future.