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Why investors want more Fed stimulus

(MoneyWatch) An extension of the Fed's current longer-term bond buying program, known as Operation Twist, would been a boon for stocks in the second half of the year, says economist Ed Yardeni in a new note to clients.

The first two rounds of quantitative easing were great for markets, Yardeni, president of Yardeni Research, notes, so it's little wonder traders and investors are hankering for QE 3, or at least an extension of the current operation, which ends in June.

However, that may not come to pass. As MoneyWatch's Mark Thoma writes, Ben Bernanke and the Fed are currently exploring other unconventional options to lower long-term rates without sparking inflation.

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Quantitative easing and the current stimulus policy boosts inflationary expectations by lowering the risk of deflation, Yardeni says. That benefits risky assets and their valuation. See the chart below showing market performance during QE 1,  QE 2 and Operation Twist, courtesy of Yardeni Research:

Yardeni Research, Standard and Poor's

The S&P 500 rose 36.4% during QE 1, which spanned from Nov. 25, 2008, through the end of March 2010, and it rose 10.2% during QE 2 from Nov. 3, 2010, through the end of June 2011, Yardeni notes.

"It rose much more, by 24.1%, if we start the clock on Aug. 27, 2010, when Fed Chairman Ben Bernanke first hinted that a second round of quantitative easing was on the way," writes Yardeni. Meanwhile, since Operation Twist was announced on Sept. 21, 2011, the S&P 500 is up 15.9%.

However, between the end of QE 1 and Bernanke's speech on Aug. 27, 2010, the S&P 500 fell 9, Yardeni says. And between the end of QE 2 and the beginning of Operation Twist, it fell 11.7%.

"This helps to explain why stock investors are such junkies for QE," Yardeni says. With Operation Twist set to end soon, markets will be as keen as ever on the Fed's latest plan to boost the economy.

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