Implications of QE3 and Investment Outlook

 

 

On 9/13/2012 the Federal Reserve’s Federal Open Market Committee (FOMC) announced it will:

• Purchase additional agency mortgage-backed securities (MBS), at a pace of $40 billion per month (quantitative easing).
• Extend the average maturity of its existing holdings of securities/Treasuries through to the end of the year.
• Reinvest principal payments from agency debt & mortgage-backed securities, back into mortgage-backed securities.
• Maintain near zero fed funds rate (0 – 0.25%), and sees economic conditions that warrant it being kept through mid-2015.

 

The FOMC confirmed the highly anticipated move that it would implement another round of stimulus and quantitative easing known as QE3.  It will purchase additional agency mortgage-backed securities (MBS) and extend the average maturity of existing holdings of securities, while continuing to reinvest principal payments back into MBS. The two actions by the fed will increase its holdings of longer term securities by $85 billion a month through the end of the year. The Federal Reserve Bank of New York statement, confirmed that the additional purchases of agency MBS will start on 9/14/2012, and will likely total $23 billion by end of September.

 

The goal of the FOMC’s actions is to (flatten the yield curve) “put downward pressure on longer-term interest rates, support mortgage markets, and help to make broader financial conditions more accommodative”.  Its move to maintain the target federal funds rate at 0 to 0.25%, aims to “support continued progress toward maximum employment and price stability” and “anticipates that exceptionally low levels for the federal funds rate are likely to be warranted at least through mid-2015.”

 

The FOMC was also concerned that “without further policy accommodation, economic growth might not be strong enough to generate sustained improvement in labor market conditions. Furthermore, strains in global financial markets continue to pose significant downside risks to the economic outlook.”

 

What is significant, is that the Fed left the policy open-ended, willing to commit longer term.

 

 

Implications Of QE3 and Investment Outlook:

Equity Markets – Equities will likely rally on the hope that QE3 will keep the economic recovery going, and we have already seen markets rise on the day of the announcement.  However, the current rally is not based on concrete results. There has been a mix of corporate profits.  Some have been good, while others have been simply horrible.  Investors need to consider how the market will look a year or two from now?

 

Equities will continue to rise in the short term as long as US job numbers, manufacturing data, and housing numbers, continue to rise. This is the Federal Reserve’s third round of stimulus through asset purchases.  However, like QE1 and QE2, such stimulus measures are not meant to be programs that should be sustained for long periods.  The FOMC’s measures can only help to create a supportive economic environment. A real plan needs to be in place to create & sustain long term job growth.  Such a plan must come from the president himself, and it’s likely we won’t see anything until after presidential elections. How effective any plan will be, is going to be dependent on the details itself.  But it must create enough jobs to replace the ones that were lost during the financial crisis (automaker & financial sectors). According to the BLS, US unemployment in August 2012 was 8.1% (still a very high level).  The only way that jobs will be created and sustained (long term) is if companies grow & expand (which results in hiring more employees).  Manufacturing and housing data will follow only if long term employment can be created for Americans.  I don’t believe QE3 measures will guarantee this, or push the economy in that direction effectively.

The global slowdown has already affected corporate profits, and will continue put downward pressure on the US going forward. Massive job cuts are continuing worldwide, with announcements being made on a weekly basis.  It is wishful thinking to believe that US corporations will not be affected by the slowdown.

It is more likely that the broad based rally in North American equities will not be sustained.

 

Global equities will rise temporarily in hopes that confidence will return to the US consumer, which in-turn would stimulate demand for global manufacturing and exports to the US.  But the US consumer is not in a situation of prosperity, and most Americans still feel that they are in a recession.

Risks are increasing globally. If Europe’s problems are not solved, the Euro and the EU will face further probability of collapse.  Growth creators are desperately needed in Europe, and there are no signs of that on the horizon. China’s credit crisis is bursting, and the situation is continuing to spiral out of control as the repercussions of shadow banking problems & bad loans come to the forefront. Even China’s official economic data can’t hide the ugly situation there. Huge stimulus packages are being put into place, but the country also needs to worry about controlling inflation and rapidly declining revenues from the country’s largest industries.  There is still a long way to go until we see the full impact of the economic crisis from the world’s second largest economy (and yes, it is a crisis). This may eventually drag equity markets down on a global basis, which would gave way to buying opportunities.

A rally in global equities is more likely to be short lived, as these problems will take years to solve. But first, plans to fix the problem have to be conceived.

 

A Stock Picker’s Market – As stated in my 2011 article when Operation Twist 2 was announced, I believe that it will continue to be a stock picker’s market going forward as it has been in 2012.  It is likely that passive investors who invest mainly in ETFs of stock market indices will see small returns as the markets gyrate and continue to be highly volatile.  However, select stocks and a narrow selection of assets will likely continue to outperform the broader market.

 

Inflation – The large amount of money printing from the largest economies of the world make massive inflation more certain, and just a matter of time.  Bonds yields are dropping to extremely low levels, and are currently not a good investment.  Investors need to take action in order to protect against the likelihood of a high inflationary environment. 

 

Gold & Commodities – An inflationary environment bodes well for gold, but if equity markets crash gold will also likely do well.  Gold is definitely an area of opportunity, and will likely increase as a result of QE3.  It has already jumped more than $30 after the Fed’s announcement in anticipation of inflation. However, commodities (other than gold/silver) which may rise in the short term due to further debasement of the US currency, may suffer some setbacks and downward pressure down the road.  It faces declining demand (in the next few years) especially from China and will be heavily influenced by a global slowdown.  This may cause miners to decline in price creating a buying opportunity.  However, longer term, commodities will see continued demand and price increases, after China and developed economies start to grow again.

 

Canada – Canada is a nation rich in physical assets & natural resources (metals, energy), and the Canadian dollar will continue to strengthen relative to the US dollar.  This will affect trade & competitiveness.  Canada must improve its competitiveness in order to compete, as the stronger Loonie makes the US and other countries more attractive places to do business and invest in.  Canada’s household debt and dependence on the domestic real estate market continues to be of concern and poses ongoing risk to the economy. Canada’s financial sector is also heavily dependent on the domestic market.  Any trouble with consumer & housing debt will create a ripple effect.

 

Mortgages – Near zero rates usually translate into lower mortgage rates.  But exactly who will be able to take advantage of the low rates will likely depend on the bank, the conditions, and the borrower.  In Canada, the US fed rate won’t affect Canadian mortgages or the Bank of Canada’s rate.  And even if the BoC maintains a low rate, retail banks in Canada don’t follow BoC monetary policy moves.

 

 

Official FOMC statement on 9/13/2012:
•  http://www.federalreserve.gov/newsevents/press/monetary/20120913a.htm

Thanks & Happy Investing! — The Investment Blogger © 2012

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