Another round of stimulus from the Fed pushed stocks to a new multi-year high. For the week, the Dow rose 2.2%, the S&P climbed 1.9%, and the Nasdaq turned in a gain of 1.5%. Gold shot up on the news, returning a nice 1.9% and reaching a new six-month high. Like most other commodities, oil moved higher by 2.7% to a four-month high of $99 per barrel, though it crossed above the $100 level at one point. The other major type of oil, Brent, closed above $116 per barrel.
Source: MSN Moneycentral
The week started out similar to last week, quiet as we waited for the Fed decision coming on Thursday. And similar to the European Central Bank (ECB) announcement for more stimulus last week, the market shot higher on the same news from our Fed this week.
By now you’ve probably heard that the Fed announced their fourth round of stimulus which will begin immediately. They will buy $40 billion in mortgage bonds every month in addition to their current stimulus program already underway. Plus they announced interest rates will remain at record low levels until 2015.
The benefits of more stimulus was argued to be two-fold. Mortgage rates should move lower, benefitting the housing market.
The other benefit is what’s described as the “wealth effect”. Since stimulus floods money into the stock market, it increases the value of investment portfolios and retirement plans, like 401k’s or pensions. People then see that wealth, feel more confident, and spend more. It sounds nice in theory, but as we’ll discuss later, it doesn’t seem to work.
This Fed announcement was historic in that they didn’t put a limit on how long the program will last. It will remain in place until the Fed is satisfied with the improvement in the labor picture, however long that may be. If conditions deteriorate, they will increase their bond purchases (or print even more money). Additionally, they will continue their stimulus programs even after the economy shows improvement.
It was also historic in that they tied the stimulus to a specific outcome. The Fed needs to see the employment picture improve, with the unemployment rate getting down to a more normal level. Many analysts think this means around or below a 7% unemployment rate (we’re at 8.1% currently), which could be several years before achieving. That means more than $1 trillion printed in pursuit of this goal.
While the Fed has a mandate to achieve full employment, it also has a mandate to promote stable prices. Stimulus increases commodity prices, as we saw with the immediate jump in gold, oil, and other commodity prices. Fed chief Bernanke indicated that the goal of stable prices has moved to the back burner, with full employment being the primary concern.
In our view, the higher commodity prices cancel out the “wealth effect” we discussed above. It’s great that our stock portfolio is higher, but now everything costs more. That is particularly harmful to lower income groups.
It also inhibits hiring. Higher commodity prices increase the costs of doing business. When more money is spent for higher energy bills or input costs, it results in less money available to staff that business.
In the end, we’re sure this will fail, just like the other stimulus programs. And we’ll be worse off in the long run.
One last thought on this subject, the political angle could be considered in the Fed’s decision.
As we discussed two weeks ago (LINK), history has shown that the incumbent is likely to win when the market rises before the election and falls in an opposition victory. Mitt Romney has stated that if elected, he would likely replace Bernanke. Could Bernanke be trying to send markets higher to preserve his job? That is not an unreasonable question to ask.
Though we devoted an unusually large amount of this section to one topic, the subject of the Fed and other central banks around the world are easily (and unfortunately) the main factor behind the market direction at this time.
There was other news as we’ll briefly touch on. Economic data this week was mixed. Consumer confidence and small business optimism was strong, along with retail sales. However, our exports have weakened, industrial production fell, and inflation has risen due to higher gas prices. Though the stock market rises, the economy still struggles.
Next week
Next week doesn’t look to have the excitement of the last two weeks. There will be a few regional Fed Presidents speaking, plus there will be some economic data releases, though nothing major. We will get info on manufacturing in the New York region, plus housing data and leading economic indicators.
Investment Strategy
With the Fed continuing to do panic-era responses to fix a slow economy, what was once non-traditional and even unimaginable, has now become mainstream. To make money in this environment, you have to be in “risky assets” like stocks and commodities. The Fed has even said as much.
You would think more people would be happy when stock markets reach multi-year highs. Most investors have come to realize that while this sugar high is great for our portfolios, it does little to help the economy and produces long-term negative consequences. So while we like seeing markets reach new highs, we have concerns for when the party ends and the crash occurs. We do not see it ending well.
We really don’t like adding new money to a market that is sitting at new highs. Agility remains important here.
In stocks, we still like large cap higher-quality and dividend paying stocks. Smaller and little-known stocks with low correlation to the market (and Europe) are also promising. There is always the opportunity to find an undervalued individual stock at any time, as well.
We continue to like gold for the long term, as it will do well with debt problems, further bailouts, and stimulus programs. We wouldn’t add more at this point, but would not look to sell, either.
We like other commodities for the long term and had feared a slowdown in China and the other BRIC countries (Brazil, Russia, and India), pushing commodity prices lower in the short run. However, the Fed has pumped this sector up and prices may continue to rise from here.
Treasury bonds yields have moved off their historic lows (with prices near historic highs), but we wouldn’t yet consider the trend to be changing in this direction. A short position (bet on a decline in price) provides a nice hedge here but we believe the potential for profit is low at this time.
On the bond theme, we think TIPs are important as we still expect inflation to increase. Municipal bonds also work and there are some nice yielding bonds out there now (try to avoid muni funds and buy the actual bond if possible), though our concern has increased as the pace of distressed municipalities is increasing. Additionally, higher taxes from the health care law will increase the attractiveness of these bonds in the future.
Finally, in international stocks, we favor developed international markets as opposed to emerging.
These day-to-day and week-to-week fluctuations have little impact on positions we intend to hold for several years or longer. Our short and medium term investments are the only positions affected by these daily and weekly fluctuations.
By now you’ve probably heard that the Fed announced their fourth round of stimulus which will begin immediately. They will buy $40 billion in mortgage bonds every month in addition to their current stimulus program already underway. Plus they announced interest rates will remain at record low levels until 2015.
The benefits of more stimulus was argued to be two-fold. Mortgage rates should move lower, benefitting the housing market.
The other benefit is what’s described as the “wealth effect”. Since stimulus floods money into the stock market, it increases the value of investment portfolios and retirement plans, like 401k’s or pensions. People then see that wealth, feel more confident, and spend more. It sounds nice in theory, but as we’ll discuss later, it doesn’t seem to work.
This Fed announcement was historic in that they didn’t put a limit on how long the program will last. It will remain in place until the Fed is satisfied with the improvement in the labor picture, however long that may be. If conditions deteriorate, they will increase their bond purchases (or print even more money). Additionally, they will continue their stimulus programs even after the economy shows improvement.
It was also historic in that they tied the stimulus to a specific outcome. The Fed needs to see the employment picture improve, with the unemployment rate getting down to a more normal level. Many analysts think this means around or below a 7% unemployment rate (we’re at 8.1% currently), which could be several years before achieving. That means more than $1 trillion printed in pursuit of this goal.
While the Fed has a mandate to achieve full employment, it also has a mandate to promote stable prices. Stimulus increases commodity prices, as we saw with the immediate jump in gold, oil, and other commodity prices. Fed chief Bernanke indicated that the goal of stable prices has moved to the back burner, with full employment being the primary concern.
In our view, the higher commodity prices cancel out the “wealth effect” we discussed above. It’s great that our stock portfolio is higher, but now everything costs more. That is particularly harmful to lower income groups.
It also inhibits hiring. Higher commodity prices increase the costs of doing business. When more money is spent for higher energy bills or input costs, it results in less money available to staff that business.
In the end, we’re sure this will fail, just like the other stimulus programs. And we’ll be worse off in the long run.
One last thought on this subject, the political angle could be considered in the Fed’s decision.
As we discussed two weeks ago (LINK), history has shown that the incumbent is likely to win when the market rises before the election and falls in an opposition victory. Mitt Romney has stated that if elected, he would likely replace Bernanke. Could Bernanke be trying to send markets higher to preserve his job? That is not an unreasonable question to ask.
Though we devoted an unusually large amount of this section to one topic, the subject of the Fed and other central banks around the world are easily (and unfortunately) the main factor behind the market direction at this time.
There was other news as we’ll briefly touch on. Economic data this week was mixed. Consumer confidence and small business optimism was strong, along with retail sales. However, our exports have weakened, industrial production fell, and inflation has risen due to higher gas prices. Though the stock market rises, the economy still struggles.
Next week
Next week doesn’t look to have the excitement of the last two weeks. There will be a few regional Fed Presidents speaking, plus there will be some economic data releases, though nothing major. We will get info on manufacturing in the New York region, plus housing data and leading economic indicators.
Investment Strategy
With the Fed continuing to do panic-era responses to fix a slow economy, what was once non-traditional and even unimaginable, has now become mainstream. To make money in this environment, you have to be in “risky assets” like stocks and commodities. The Fed has even said as much.
You would think more people would be happy when stock markets reach multi-year highs. Most investors have come to realize that while this sugar high is great for our portfolios, it does little to help the economy and produces long-term negative consequences. So while we like seeing markets reach new highs, we have concerns for when the party ends and the crash occurs. We do not see it ending well.
We really don’t like adding new money to a market that is sitting at new highs. Agility remains important here.
In stocks, we still like large cap higher-quality and dividend paying stocks. Smaller and little-known stocks with low correlation to the market (and Europe) are also promising. There is always the opportunity to find an undervalued individual stock at any time, as well.
We continue to like gold for the long term, as it will do well with debt problems, further bailouts, and stimulus programs. We wouldn’t add more at this point, but would not look to sell, either.
We like other commodities for the long term and had feared a slowdown in China and the other BRIC countries (Brazil, Russia, and India), pushing commodity prices lower in the short run. However, the Fed has pumped this sector up and prices may continue to rise from here.
Treasury bonds yields have moved off their historic lows (with prices near historic highs), but we wouldn’t yet consider the trend to be changing in this direction. A short position (bet on a decline in price) provides a nice hedge here but we believe the potential for profit is low at this time.
On the bond theme, we think TIPs are important as we still expect inflation to increase. Municipal bonds also work and there are some nice yielding bonds out there now (try to avoid muni funds and buy the actual bond if possible), though our concern has increased as the pace of distressed municipalities is increasing. Additionally, higher taxes from the health care law will increase the attractiveness of these bonds in the future.
Finally, in international stocks, we favor developed international markets as opposed to emerging.
These day-to-day and week-to-week fluctuations have little impact on positions we intend to hold for several years or longer. Our short and medium term investments are the only positions affected by these daily and weekly fluctuations.
