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QE4-Ever?

[Finance, Investing & The Economy]



 
FED ALERT - QE4-Ever?
On Thursday, September 13th, the Federal Reserve announced an aggressive posture to support continued progress toward maximum employment and price stability. The Committee expects that a highly accommodative stance of monetary policy will remain appropriate for a considerable time after the economic recovery strengthens. In particular, the Committee also decided to keep the target range for the federal funds rate at 0 to 1/4 percent and currently anticipates that exceptionally low levels for the federal funds rate are likely to be warranted at least through mid-2015. The Fed agreed to increase policy accommodation by purchasing additional agency mortgage-backed securities at a pace of $40 billion per month and maintaining its existing policy of reinvesting principal payments from its holdings of agency debt and agency mortgage-backed securities in agency mortgage-backed securities. These actions together will increase the Committee's holdings of longer-term securities by about $85 billion each month through the end of the year. If the outlook for the labor market does not improve substantially, the Committee will continue its purchases of agency mortgage-backed securities, undertake additional asset purchases, and employ its other policy tools as appropriate until such improvement is achieved in a context of price stability. The Committee is 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.

Unfortunately, the first two rounds of QE couldn’t get US GDP above 2% and QE3 is likely to be even less effective. Perhaps investor’s optimistic outlook is based on what appears to be a deep abiding faith in the ability of the central banks to manipulate the economy. The recently announced bond buying program by the ECB hasn’t changed any forecasts for economic growth in Europe. Rather, there will be additional liquidity in the credit markets that will reduce the risk of a credit implosion, which is what caused so much turmoil in the US in 2008.

 
Market Commentary:
For the month of August, the stock market continued to deflect worrisome news and posted solid gains. This “Hope Rally” of sorts defies a myriad a worries on Wall Street—from the so-called fiscal cliff in the U.S. to Europe's financial mess to turmoil in the Mideast. Central banks around the globe announced further quantitative easing and maintained ultra-low interest rates, providing support to stock prices. Current ECB Chairman Mario Draghi’s “do whatever it takes” mentality appears to have settled investor’s fears, making riskier assets more attractive.  The idea is that additional liquidity promotes economic growth, reduces the risk of a credit meltdown and creates additional demand for equities.

Since August 20th, the following data showed the top global economies are all weakening.

1.         Japanese July retail sales (-0.8%) and industrial production (-1.2%) fell sharply.

2.         The government Chinese manufacturing survey fell below 50, to 49.2 in August.

3.         German retail sales unexpectedly fell 0.9% in July from June.

4.         Brazil posted lower than expected 1.6% annual growth in the second quarter.

5.         US economic data have been disappointing and have led us to a lower our third quarter GDP estimate.

The data suggests that every major global company is experiencing slower growth. Yet, global stock markets are doing well in large part because of expectations of further central bank quantitative easing. From an investment standpoint, there is little evidence that a bad outcome is currently baked into the market. It appears that the basic fundamentals for the stock markets are not improving, evidenced by lower corporate earnings and declining economic trends.

Profits for the S&P 500 in aggregate for the third quarter are expected to decline from the same quarter a year ago, and the poor economic outlook suggests that a rebound in fourth quarter profits, or even in early 2013, is unlikely. If the impending “Fiscal Cliff” were to actually happen, stocks would likely suffer a decline, along with other risky assets like commodities and high yield bonds. The odds still favor a last minute compromise.

As the market continues to climb the proverbial wall of worry, perhaps the market is ‘hopeful’ that the presidential and congressional elections in November will lead to Washington’s warring parties reaching some sort of agreement on how to forestall fiscal Armageddon by raising some taxes and paring some mandated cuts. As for Europe’s troubles, perhaps investors have grown accustomed to living with the uncertainty overseas.

While the US election is still very much an open contest, current polls suggest that the most likely scenario is that President Obama is reelected, albeit in a very close contest. At the same time, polls indicate that Republicans are in little danger of losing the House, and the Senate looks set to be a close 50-50 split. In other words, Washington is likely to be more divided in 2013 than it was in 2012, which could make it marginally more difficult to reach a compromise during the brief period between the election and the New Year.

However, even if avoided, the fiscal cliff poses two challenges for investors: volatility is likely to rise on the lingering uncertainty and that uncertainty may exert some modest drag on Q4 economic growth. Make no mistake, the fiscal cliff is a big deal. The Congressional Budget Office estimates that should the fiscal cliff occur on schedule, the economy will contract by 0.50% next year, hitting at a time when the economy is still in the midst of a fragile recovery, with US GDP growing by less than 2%.
 

 

Technically, our primary indicator The NYSE Bullish Percent remains on a buy signal. The short-term indicators closed the month out on a positive note but vacillated between buy and sell signals during the month. The volume was still low and the volatility index (VIX) traded down on the month suggesting complacency on the part of investors.

Value stocks, which were among the weak performers last month, outperformed. In addition, high beta and price momentum stocks did well. Stocks in the large cap, growth and positive earnings categories fared relatively worse for the month. Most of the industry groups we cover had positive average price gains for the month. Among the better performers were companies in the construction products, food and retail groups. Notably weak industry groups included those in the transportation and utility sectors.

Perhaps the summer rally is evidence of the market's fortitude in the face of well-known concerns based on the hard data of economic and earnings trends. The optimism is based largely on hopes that US and European central bank liquidity actions will increase demand for stocks. For now, the markets are clearly reacting to everything related to central banks and ignoring economic and earnings trends. This short term bullish sentiment can easily dominate market sentiment for a while. However, in the long run, the fundamentals always win out.



  Raymond C. Baker Jr. is TPC Finance, Investing & The Economy Editor, a category in which financial professionals are invited to submit articles.

Ray Baker is Chief Market Strategist and Portfolio Manager with  Wespac Advisors.  Baker has been a life-long professional in the Financial Markets.

You might also want to read:  Can America Regain it's AAA Rating? Also written by Raymond. C. Baker, Jr.


Aren't you hopeful that, once past this election, American business will feel more certain of the coming economic environment, put more people to work and the economy will stabilize? As your article title suggests, we can't artificially control interest rates forever...
Oct 16, 2012


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