You've likely been wondering what's going on with the market.
The S&P 500 is up about +12% since the start of September, yet
unemployment is still high, the U.S.deficit is still enormous and
the overall economic picture is still hazy. What's behind it all?
I think most of the answer lies in QE2.
No, not the Queen Elizabeth 2 ocean liner. QE2 is what the business
media is calling the pending second wave of quantitative easing by
the U.S. Federal Reserve.
To stimulate theeconomy , the U.S. Federal Reserve has set
short-term interest rates at all-time lows. But theeconomy is still
sluggish and unemployment remains stubbornly high. To further
stimulate theeconomy ,
has stated that it is likely to try a little-used tool called
Quantitative easing is used to hold or push down long-term interest
rates. To do this, the
buys long-term Treasury bonds, keeping their prices higher -- and
The hope is that by making Treasuries less attractive, banks (which
have been borrowing for next to nothing and buying safe Treasuries)
will be more apt to lend to businesses and consumers.
Quantitative easing is experimental, and whether it will really
help the broadereconomy is unknown. Even Ben Bernanke says that "we
have less experience in judging the economic effects of this policy
instrument." But one thing is almost certain: The Fed's expected
move is good for almost all income investments -- and great for
So for which securities would the easing be great?
I've found two: foreign income investments and lenders. If the Fed
announces a quantitative easing program at its next meeting, these
are spots I want to be.
Foreign Income Investments
: There is no free lunch when it comes to Federal Reserve
intervention. When the central bank buys Treasury bonds, it is
likely that it will turn on the printing press to pay for them. In
the tried and true law of supply and demand, the new money supply
is likely to weigh on the relative value of the U.S. dollar. And to
some extent, just the rumor of QE2 has put some pressure on the
. The euro has gained more than +8% against the dollar since the
start of September.
But what is bad for the U.S. dollar is good for other foreign
currencies. A weaker dollar means companies earning revenue in a
foreigncurrency will be making more when computed in U.S. dollars.
It also means dividends paid in foreign currencies will be worth
more U.S. dollars.
: When short- and long-term rates are held in check, lenders tend
to do well. They can borrow money cheaply and lend it out at higher
rates. Historically, that has been good for banks. But for now, the
big banks are embroiled in controversy, stemming from their
less-than-stellar foreclosure processes. [Read: "
The Best-Managed Bank in America
But there is another type of lender that should do very well in an
environment of lower interest rates.
Business development companies (BDCs)
act asventure capital firms, lending money to small companies that
can't easily get financing elsewhere. I already have two BDCs in my
real-money portfolio for
The Daily Paycheck
. Both have been good performers with above-average yields.
Main Street Capital Corporation (
, for example, has returned an outstanding +25% with a
[For more on BDCs, you'll like my colleague Carla Pasternak's
on the topic.]
Banks are still firming up their balance sheets and are reluctant
to loan. In its third-quarter financial report,
JPMorgan Chase (
announced a mere +1% increase in its outstanding commercial loan
portfolio. So with less competition in the mix, BDCs may have
access to even more lucrative lending deals.
The market rally during the past month and a half has reduced the
number of above-averageyield opportunities. But BDCs, required by
law to distribute 90% of their taxable income to shareholders, are
still offering rich yields.
Action to Take -->
The market expects the Federal Reserve to announce its program of
quantitative easing at its next meeting, scheduled for November
3rd. We've already seen the value of the dollar and the price of
Treasuries bounce around in anticipation.
But regardless of the market's reaction once the announcement is
made, the longer-term effects of easing should make this a
friendlier environment for BDCs and foreign investments
specifically -- and all fixed income securities in general.
-- Amy Calistri
A graduate of both Columbia University and The University of
Texas, Amy's experience includes managing $5 million in trust
funds, economic consulting and financial risk management. Read
Disclosure: Neither Amy Calistri nor StreetAuthority, LLC hold
positions in any securities mentioned in this article.
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