Terry Sawchuk Founder & Chairman
QE3, Quantitative Easing round 3, has arrived. What is QE3 and how will this affect the economy and the stock market. I will try to be brief so as not to bore you to tears. First, let’s answer the question of what is QE3. There are 4 components to this round of QE. First, Ben Bernanke announced this week that the Fed will buy up to $40 billion of mortgage backed securities per month. The specific amount of purchases will be detailed around the last business day of the prior month. Second, the Fed did not announce the total amount of purchases or the time frame for these purchases. This left the program “open ended”. In the past the Fed gave a specific timeframe for the purchases. Third, Operation Twist will continue at least through the end of 2012. Operation Twist is a program where the Fed sells short term maturing bonds and buys longer term bonds to help force interest rates down. Fourth, the Fed announced that they plan to keep interest rates “exceptionally low” until 2015.
It is interesting to stand back and ask yourself why would the Fed engage in another round of stimulus? The Fed statement noted: ”The Committee is concerned that, without further policy accommodation, economic growth might not be strong enough to generate sustained improvement in labor market conditions.” Does the Fed know something we don’t? Is the economy slowing again? Just this past week we got slightly better than expected jobless claims but the new jobs numbers coming out were a disappointment. Housing numbers came in a little better than expected as did the auto sales. If economy is showing sign of life why would the Fed move forward with QE3?
During my recent stint as a juror on a federal case in Ann Arbor the notion that there are two sides to every story was reinforced. It is also possible that the story is the same but tainted or manipulated to a particular view for one reason or another. Here are just a few things to consider. Many people have noted that Bernanke’s intent with QE is to prop up the markets in an election year to help get his current boss reelected as President. There seems to be just as many people noting that the printing of more money and the risk of inflation will assist the Republicans in winning back the White House. There is an old investment saying; “don’t fight the Fed”. Thus when the Fed acts you need to follow and the announcement of QE3 means the markets should likely go higher. The other side of the coin; this is the third attempt by the Fed to jump start a slowing or sluggish economy. Obviously this course of action is not working or we wouldn’t be doing this for the third time. The Fed feels that keeping rates low will help small businesses obtain loans. Many feel that small businesses don’t need loans, they need customers. The Fed feels that keep interest rates low will assist the housing market by making mortgages more affordable. Others feel that interest rates have been low for a long time and the housing markets remains troubled due to higher unemployment resulting in fewer people able to obtain loans. The Fed feels lower interest rates will help current homeowners refinance their debt making it easier to stay current with their mortgage payments. Others feel that most people who could refinance already have done so and those that would like to are unable because the debt is more than the value of their current home.
Art Cashin, head of floor operations for an international investment bank, noted this past week that the Fed is trying to raise home prices so people’s net worth increases. He also noted that Bernanke stated he is trying to raise stock prices. Terry had suggested this was the case, as the Fed engaged in the earlier rounds of QE1 and QE2. We had several conversations where he felt that even though the Fed didn’t come out and say it directly that they intended to raise stock prices. The Fed is trying to create inflation. That may scare some people as inflation is viewed by some as bad, or even real bad. While I will agree that hyper inflation is not good some inflation is necessary. With inflation we do see stock prices go up, home prices go up, income usually goes up and our net worth usually goes up. It has to be noted, inflation is better than deflation.
There remain two sides to every story. Terry and I will continue to evaluate both sides of these stories and adjust the portfolios as necessary. At this very instance we are not making changes. That could change rapidly as new information comes to light. More frequent changes are possible in the coming months as the election draws closer and news out of Europe continues to flow. Stay tuned.
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