QE3 Since When Is Pushing on the Accelerator a Good Way to Avoid a Wall?

 

We have been waiting for it more anxiously than the next release date of a U2 show. After a good 12 months of waiting, the market finally got what it was asking for: more money pumped in the system. Last week, Big Ben (Ben Bernanke) revived the stock market by announcing another round of Quantitative Easing surnamed QE3. The market surged by almost 2% in a single day. I guess we can call this good news… but is it really?

 

Quantitative Easing (QE) History So Far…

 

 

What is now a common term (QE) was almost nonexistent prior to the credit crisis back in 2008. Only Japan had used this method in the past. During the credit crunch, most banks were having a hard time with their liquidity and didn’t want to lend to anybody. Banks did not trust each other at that time. Since money is like blood in our veins, when banks stopped lending, the wheel of capitalism was quickly stopped as if it just had a heart attack. It looks a little bit like this:

 

 

Since rates weren’t the issue (they were already dropped to 0% at that time), the FED needed to find another way to revive the economy. Without liquidity flowing, there was no way growth would come back. The problem was caused by mortgage back securities (MBS) that were used as commercial paper. Those MBS were “toxic” and contained several bad mortgages along with a leveraged effect. In the end, nobody knew what was inside the toxic MBS and this is why nobody wanted to trade them anymore. This was causing huge losses on banks’ balance sheets as commercial paper was usually seen as short term assets.

 

This is why in November 2008, the FED started their first quantitative easing (QE1) operation with a first round of $600B purchases of MBS. It had a huge effect on the market and this is when the economy started to walk again. This is what led to the 2009 market rally.

 

In November 2010, FED announced another round of $600B to purchase treasury securities. The goal was, again, to pump liquidity into the market so trades would still occur. It’s like artificially pumping a patient’s heart in the hopes that the heart will restart.

 

In September 2012, we are now up for a third QE (QE3) where the FED will buy for $40B per month of MBS. While the first two QE goals were to inject liquidity in the market, the third round aims specifically to reduce mortgage rates. The idea is to create more demand for homes (as several Americans currently pay a higher rent than a mortgage payment due to job instability) and for more refinancing. In other words, we are trying to increase jobs through more consumer spending via the home market. Hum… this reminds me of 2003-2007 home market….

 

What’s the Point Of “Easing” The Economy

 

In a “normal” world, the central bank’s job is pretty easy. Inflation goes up, they increase rates, inflation comes down and unemployment goes up, they decrease rates. Then it becomes a real nightmare when inflation may surge at any moment, unemployment rate is incredibly high and the interest rate is at 0-0.25%. Even calling the “forever low rate” policy until 2015 is not enough to convince the stock market. Companies prefer to be cash rich then using the cheapest leverage ever.

 

This is why Big Ben came up with the idea of printing money (literally) to buy assets nobody else wants. By sponsoring the stock market, he hopes that the economy will continue to grow and consumers will spend. While QE1 was a great success and did what it was supposed to (restart the engine of the economy), QE2 didn’t do much. Is QE3 the answer to the US economic problem? I doubt it…

 

Possible Impact of QE3

 

The immediate impact that I see from QE3 is not a better economy but rather a weaker US dollar. By printing billions and billions of dollars, you start diluting your value. A weak US dollar might be good to stimulate exports. This is not necessarily a bad thing, especially for small and medium size companies who try to compete in the market.

 

However, printing so many bills can also lead to inflation. What would happen if the economy gets back on track and inflation goes up to 5%? Increasing rates in a fragile economy would probably kill the economic impetus within months. On the other hand, hyperinflation is not something you want to see in a developed country.

I’m just wondering how good it to be to inject more billions when 1.2 trillion was not enough? There is a limit of how much CPR you can do on a human body. I guess this is the same thing with the economy. At one point, aren’t we going to create a Frankenstein?

 

Gold or Oil?

 

The first reflex of many speculators was to go into gold (to protect their money from eventual hyperinflation) or to aim for oil (as an exploding economy will push prices higher). I can see both happening (gold and oil going up) but would rather bet on oil for the moment. I guess that the fact that I hold 2 oil companies (HSE and CVX) makes me hope that both companies will benefit from a potential economic boost.

 

But to be honest, I’m not convinced that pumping more money into the market is a good idea. It also sends the message that investors, banks, companies can do pretty much whatever they feel like doing, Big Ben will always be there to cover their mistakes…

 

How to Position Your Stocks

 

So how do you position your portfolio in light of QE3 expectations? I think that companies that have a strong potential for exportation will be the true winners. It’s almost impossible to see a strong US dollar in 2013. Therefore, exports should increase significantly.

 

Then, resources companies should also benefit from a low interest environment. Combined with a growing economy, we can see good things happening on this side too. Since I’m already into 2 oil companies and 1 rare earth producer (VNP), I’m not going to buy more for my own portfolio.

 

I’m actually going to focus on cash rich companies and not change my current portfolio for the moment. VNP is actually gaining some momentum at the moment so I’ll keep the stock and wait for the next quarterly results. I have my eyes on McDonald’s (MCD) at the moment but missed a great opportunity to sell STX at $35 and switch my money over to MCD. Now that STX has dropped to $30 or so, I will keep it and earn the strong dividends.

 

If I had more money to invest today, I would still invest in the US stock market even though I’m Canadian. I find that the overall stock market is still undervalued and that has nothing to do with QE3. I don’t expect many results from QE3 besides a weaker US dollar (which is always good for new buys for Canadians!).

 

Do you think that QE3 will have an impact on the economy or is the FED is just pumping money in the air?

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