The sole purpose of the Federal’s Reserve’s recent moves and commentary is to inspire the economy‘s “animal spirits.” The most recent action, known as QE3, or the third round of quantitative easing, is simply an effort to provide a spark where none exists.#-ad_banner-#

While the Fed spent the summer contemplating if and when to make such a move, the economy looked tired, as a series of readings gave the impression of a cool-down from more impressive economic reports in the spring. But as the Fed gears up for action, the economy is beginning to show signs of an even deeper slowdown, and it’s fair to wonder if QE3 will provide much help at all –despite the impression a rising stock market may give.

As far as Federal Reserve Chairman Ben Bernanke is concerned, the economy can finally break its malaise if banks step up lending and companies start making key internal investments. So QE3’s primary impact is to lower the cost of money by placing downward pressure on interest rates. Cheaper money often helps companies generate a more robust rate of return. This is known as “the hurdle rate,” and as financing costs drop, the hurdle gets lowered.

Yet these companies are often sitting on ample cash anyway and need little incentive to put money into play. Instead, their financing decisions are more strictly based on expectations for demand — and not simply the cost of funds. 

“…lately, corporate America has been trimming capital goods in orders in fear of weaker growth, so it’s not clear that companies will tap into equities for financing new capital projects,” noted an economist at CIBC.

Exports and retail: Two pillars giving way 
The only reason companies invest in new growth opportunities is if they foresee tangible near-term and long-term benefits. That means thriving export market opportunities, or a more free-spending consumer here in the United States. On both fronts, there are reasons for concern.

Few appreciate just how well U.S. exports have fared, despite the tough global economic environment. But many warning signs are beginning to appear. Consider this stat: The amount of exported goods rose at least $10 billion from the prior year’s month from January 2010 until August 2011. That figure stayed in the $5-8 billion range in subsequent months. Yet in July 2012, that figure slipped to around $4 billion for the first time in nearly three years. In addition, the 3.3% year-over-year growth rate in monthly exports was also the lowest in several years. Deutsche Bank economists warn that “a key leading indicator of exports — the ISM new export orders — also points to contracting volumes.” (The next report, for August 2011, is slated for release on Oct. 11, 2012.)

U.S. Exports In the Past Two Years

It’s important to note that if export opportunities are diminishing, then companies will become increasingly reliant on the U.S. consumers to support demand. Here again, the numbers are troublesome. Retail sales rose a seemingly impressive 0.9% in August 2012 when compared to a year ago. Yet much of that gain is attributable to higher gasoline prices at the pump. Back out that spike and retail sales actually fell 0.1%. The biggest areas of weakness: General merchandise (-0.3%), clothing (-1.1%) and electronics (-1.4%). 

After digesting those figures, Merrill Lynch’s economists now think the U.S. economy’s GDP expanded just 1.1% in the third quarter. That would be the worst showing since the first quarter of 2011, when it grew just 0.4%. You would have to go back to the Great Recession of 2008 and 2009 to otherwise find such a period of anemic growth (or outright recession).

Risks to Consider: The U.S. economy did manage to rebound during the rest of 2011 after it slowed sharply in the first quarter, so it’s important to watch ongoing trends to see if they start to impact the fourth quarter as well, which starts in just a few weeks.

Action to Take –> It’s now increasingly clear why the Federal Reserve would like to help the economy. But past rounds of quantitative easing have done more for stock prices and speculative commodities such as gold, than they have actually done for the economy. That’s why some suspect the Fed is “pushing on a string” with its efforts and will be unable to effectively inspire lenders to lend and businesses to invest.

That’s why you need to guard against further euphoria in today’s stock market. Until and unless we see signs of an economic rebound, the bias remains for a more sober tone from stocks as the next earnings season gets underway. As I’ve noted before, there’s no shame in locking in profits on solid recent gainers. The case for further upside seems limited in the near-term, and you may be able to buy these stocks back at lower prices if the economy truly stalls out.