By Greg Jensen
Last week the Federal Reserve announced another round of quantitative easing, or QE3. For those that haven’t been paying attention I should point out that quantitative easing is the process by which the central bank buys bonds (or other interest bearing securities) in the open market. The purpose is two-fold.
Firstly, as the price of bonds is forced up, so interest rates on them are driven lower. Lower rates are meant to encourage lending and borrowing, which helps to stimulate the economy. Secondly, QE is effectively printing money. The Fed buys these securities by issuing a credit to the holder. They don’t need anything backing the credit. If the Fed says you have an extra billion dollars in your account, then you do. In other words, they add more money to the system, another thing designed to stimulate. The long-term effects of this are to devalue the currency (more supply equals less value) and flirt with inflation. This long-term risk has until now been tolerated by the market as the price to pay for the perceived short-term benefits.
It’ll Be Different This Time….
This time around, however, there was a significant difference. The announcement indicated that the Federal Reserve would be buying $40 Billion of mortgage backed securities (MBS) each month, but with no maximum amount or time limit. The use of MBS is an attempt to further lower the mortgage rate. The indefinite time period is an attempt to avoid the situation where the market receives a boost, then crashes at the end of the program. I can’t shake the image of a market being drip-fed adrenaline, rather than given a jolt.
The image of a drug-dependent patient building resistance is borne out when we look at the numbers. It seems that each shot is having less effect.
The pattern here is pronounced. Each phase of quantitative easing has less short term effect. You can argue that this is due to the market now anticipating the moves and climbing before the actual announcement, but that was true for phases 2 and 3 and the effect is still lessening. Given that the unlimited nature of QE3 was a surprise to the market, one would expect the reaction to the announcement to be significant. You cannot argue that the amount of QE3 isn’t enough. I mean, how much more than unlimited do you want?
What Can I Do?
If you waited for the announcement, and then invested in the broad stock market, you would be a little disappointed right now. Given that the short-term benefit is muted at best, investors may be better off preparing for the long-term risks. It may pay to focus on the debasement of the U.S. dollar. Currency plays are the most obvious way to do this. A case can be made that, despite a recent run up, buying Australian Dollars against U.S. Dollars (AUD/USD) would be the best way to go. Any inflationary pressure can benefit an economy (Australia’s) that has a large base in commodities, while the trade would also gain from a weaker U.S. dollar.
Many people don’t have access to, or don’t like the volatility of, FX trading, however. For regular investors there is another currency that offers both benefits: gold. Gold has all of the characteristics of a currency, but there is no central government bank that can print more of it. More can be mined, but there is not an unlimited supply. For simplicity, the SPDR Gold Shares ETF (Ticker:GLD) is hard to beat, being readily available with good liquidity. This is still paper-based, however, so many people prefer to invest directly in bullion.
If you are looking solely for a solution in stocks, large U.S. companies with significant overseas revenues could be the answer. Don’t be afraid of the obvious. You are not looking for a home run here, just protecting against some possible consequences of intervention. Yum Brands (YUM), Coca-Cola (KO), McDonalds (MCD) and Phillip Morris International (PM) all fit the bill.
When the Federal Reserve announces that they will throw unlimited amounts of money at the market and the market shrugs its shoulders, the law of diminishing returns is in full swing. The dependency on these periodic injections of cash has become worrying, and it is doubly so when the market seems to treat each one as inevitable and needed. It would seem prudent for investors to now accept that the benefits are limited and begin to focus on the risks. They are still there, but it seems that the rewards, in market terms at least, are not.
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